October 8 Market Update: Dollars and Gold

US Dollar
We've written about the dollar's double top, and of course, the poor fundamentals, for some time now.  Inevitably, though, things run counter to the prevailing trend for a while.  While the dollar has had minor "bounces" from its downtrend which started in March, it will, at some point, have to have a larger and more sustained countertrend rally.  As we posted earlier today, we are of the belief that this more substantial rally will occur when the dollar reaches the 72 area, though it could (obviously) occur earlier.  We will be watching to see if the circumstances change.  However, the 72 region has been strong support in the past, and any time you have a double top pattern, you must expect that the entire rally leading up to the pattern will retraced.  Thus, the likelihood of a substantial rally at 72, we believe, is in the cards.  One could also view this chart, also as we've discussed before, as a descending triangle.  That pattern would take the dollar down to the 67 range.  Either way, the 70-72 range is likely to offer substantial support.

You can see that we are approaching oversold longer term and downward momentum is slowing.

We must look to the short term chart to determine what to expect over the next few days to few weeks.  We can see that in the short term, the dollar has more downside room to run.  The 50 day moving average, currently at 77.63, has been resistance since the decline in March.  If the dollar were to definitely break above the 50 day moving average at any point between now and the end of the head and shoulders target of 72, that would be taken as a warning that a reversal may be underway.  Other indications would be a rise in the RSI above 50, and of course, a return of credit stress.

As we reported on Monday, the dollar broke down from its pennant formation and retested 76 today.  Much like the response it had at the 78 level, there has been a dip below support and now a rebounding.  As of this writing, the dollar is at 76.08, having recovered from a 75.80 intraday low.  As we discussed when the dollar was at the 78 level, we need to see a definitive breakdown below the 76 level to consider that level broken.  Definitive, in this sense is as much an art as anything, but we would be looking for a 3% move below support that holds for a day or two and continues to move down.  At the same time, we can see that the short term dollar is approaching oversold on the 14 day stochastic.  We still expect a little more rally in the dollar at this level--possibly up to the 50 day moving average before it comes back to test 76 again.  We would expect to see a failure at that stage and a fast move down toward 72.

To illustrate a possible scenario, we can look at the short term dollar chart that shows an interesting chart pattern, a falling (descending) wedge.

First, we can see that the RSI has called intermediate dollar reversals very well.  Since we're not at the 30 level yet, the dollar probably has more downside--to 72, we believe, when the dollar will show up as strongly oversold, and asset prices will have gone parabolic for a bit.  This scenario would be a classic "melt up" top.

The dollar is in a descending wedge as can be seen by the blue lines on the chart above.  Many deflationists may start arguing that the dollar is set to bottom and rise.  First, wedges, as a general rule, do not imply changes in trend--only consolidation patterns.  Second, rising and falling wedges are notoriously poor performers with high failure rates, while double top and descending wedge patterns have some of the highest success rates.  In any case, you can see that a rise in the dollar above its 50 day moving average would signal that this pattern was in play.  Until the dollar breaks that level to the upside, there should be little concern.

Gold
In contrast, gold just activated its long term inverse head and shoulders pattern that we've been writing about for months.  Gold's strength has surprised us.  We anticipated that gold would consolidate more before it broke 1000 (where we recommended buying any dips below 1000), then more between 1000 and 1020-1024, and then more after it broke 1033, before it ran through 1050.  Clearly, gold has moved beyond our expectations and surprised to the upside (this is why we rarely trade gold, instead focusing on good entry points).

Unlike the long term dollar chart, which has 67-72 as a target range, gold is poised to hit AT LEAST 1300 on its long term chart.  Of course, this depends on the dollar's actions, and we believe it is dangerous to analyze one without considering the other.

On the long chart below, we can see the neckline, broken to the upside.  We are overbought on the stochastic and approaching it on the RSI, but momentum is on gold's side and the seasonal cycle favors it.

 The short term chart is very interesting as well.  We are overbought on the RSI for gold, which signals a very likely short term consolidation, and is also oversold on the stochastic.  We would not be buyers of any gold right now, unless the dollar broke down hard through 76 to the downside.

There is minor support at 1020, but significant strength at the 990-1000 level.  We do not believe we will move below 990-1000.  Now that the inverse head and shoulders pattern on the long term chart is active, the only way of invalidating the target is if gold closes below the head at 700.  We're not holding our breath waiting for that one to happen.  It goes to show the strength of this pattern.

A Way to Play It
This brings up the issue of how to play this dynamic.

We expect that the dollar will hover around the 76 level for a bit longer, while gold consolidates its overbought condition and the dollar works off its oversold condition.  This could last as long as a couple of weeks, but may only last for a few days.  That would represent a good "gold-oriented" buying opportunity as it neared the key support lines.

Once the downtrend on the dollar resumes, which we would confirm with a convincing breakdown through the 76 level, we would expect the move to be fairly quick toward 72.  Since we know that 72 is strong support, and the "gap" between 76 and 72 is considerable, we could expect a major upward movement in gold--perhaps to that 1300 level on the long term chart.  At this stage, gold would be very, very overbought and the dollar would be very, very oversold.  There would have to be a substantial countertrend move to work off the longer term overbought and oversold conditions, perhaps bringing the dollar back up to the 80 level.  This, in turn, would force a major sell-off in gold and spark the deflationists to come out of the woodwork.

Going long gold stocks or paper gold would enable a nimble and careful trader to capitalize and a rapid, and probably manic, gold buying/dollar sell-off phase, then take the profits and buy physical gold when the trend reversed.

Another way to do this may be to leverage the gold/silver ratio.

Gold rises in times of crisis and silver outperforms during inflationary fears.  We can see that since the first dollar top in October/November of 2008, the gold:silver ratio has been declining in a predictable channel.  At the bottom of the channel, and assuming a continued dollar downtrend without a credit stress component, a trader could move to silver and ride the wave to the top of the channel, move to gold, rinse and repeat until the dollar bottomed.  You do not want to be in silver if there is a panic/deleveraging crisis.  As long as it's manic buying (and not manic selling), then silver should outperform.

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Another Take on the Markets

In summary, he's looking for a market top with 3-5% more upside before a roll over and then a 40% correction.  He agrees that the dollar rules everything else, and that the dollar is due for a short but sharp upward correction.

Longer term, the dollar will go down.



We don't agree entirely, but we have to respect others' opinions and consider the possibilities.

The dollar appears to be weakening.  After our call on the pennant, the dollar broke down and is currently testing that 76 level that we discussed earlier this week.  We're at that stage where we are going to determine whether or not the dollar is going to make a fast move toward 72, or if it will have a stronger rebound.  It's not clear yet, but we tend to believe that the dollar will not strongly rebound until it hits the 72 region, which would probably spell much more upside for gold, oil, commodities, and stocks than the trader in the video sees.

We will know soon enough.  Watch that support around 76 for clues.

Meanwhile, let's look at the S&P to see what kind of patterns we might find.

The main bullish pattern that we've discussed over and over again is the inverse head and shoulders that is currently active, with a longer term target of 1350 (not shown on the chart below to try and preserve clarity, but you can find it mentioned many times in Technical Archives as far back as July.)  Given that there's so much skepticism about this move up, we tend to believe that the 1350 level is achievable.  That would present a whole new BEARISH case that we won't really get into now, but suffice to say that if the market goes that high and rolls over, we may see a crash the likes of which has never been seen.

Here's the long term picture.

The longer term picture has no obvious concerns aside from fundamentals, which we can probably all agree are generally lousy.  Note that stocks are generally traveling in an upward channel, and that momentum is running out.  The question is going to be the degree of pullback--will this be a crash or more of a consolidation? The first thing to note about separate a real crash from a pullback would be the lower trend line that's around 1000 at this stage.  A break on the weekly chart below that and we have a potential big problem.  It would not be surprising to see a gentle downtrend toward 1000, and then a higher move as we near the lower trendline.  Note that the RSI still has "room" for an upward move.  If any major selling occurs, it will likely be when the RSI breaks over 70 or breaks down on the red upward trendline.

Let's look at the shorter term charts for some possible downward patterns.

The first pattern that we believe is more significant is this rising, broadening wedge.

There is still some short term upward momentum.  The red lines indicate support and resistance.  It is possible we'll see a rise toward 1100 on the S&P and a complete breakdown, taking us to 980.  We discussed last week that buying at the bottom of the channel would be a positive.  At this stage, we would not be moving into equities, but would generally be watching to see how this develops--holding what we have until the 1100 range or some resistance line forces a sale.  A break below that 1035 level could spell trouble as it is both a support level and the lower channel support level.  We do not have to go entirely to the top of the blue trend channel at this stage for the wedge to start breaking down.  We tend to favor more upside in the short term than downside, however.

The most concerning aspect to this pattern is that we continue to run along the upper trendline and cannot break through.  A breakthrough to the upside, of course, would be very bullish.

Another pattern that has been reported out there has been the rising wedge.

 We reported on this one last week.  Our concern was that this is not a well defined wedge.  You typically want to see the pattern move completely from one trendline to the other.  Rising bearish wedges (as compared to the rising broadening wedge in the first chart) is less dependable.  In fact, the Bombay Stock Exchange recently broke a rising bearish wedge to the upside.  Technically, this broke down, but as you can see, the market has trended higher since.  We prefer the first chart as a more dependable, better formed pattern, though the downside count on both charts moves to 880.

Of course, all of this depends on the dollar activity.  You can see the correlation between the S&P and the dollar continues on:

Until we see this dollar/asset market correlation start to break down, we can only assume that stocks will respond opposite the dollar.  One source of breakdown would be a return to the credit crisis.  As we detailed before, we should have advance warning of this condition.  The other possibility, which we tend to believe in, is that there will be an event that will decouple the general S&P from the dollar, commodities, and gold.  As of this stage, we believe that may be the announcement of holiday consumer sales that will top the markets, somewhere in Q1/2010.  Until then, we will continue to track dollar/equity correlation, and as long as the correlation remains strong, we can expect a lower dollar to equate to higher general equity prices, and vice versa.

The most likely catalyst for a strong equity market sell off in the shorter term is a rise in the dollar.  Thus far, we have not seen the bottoming pattern appear in the dollar that would be required to force asset liquidation.  That time will probably come, but it's not here yet.  Instead, our view remains that any major sell off in equities becomes a buying opportunity for stocks of commodity producers in the energy, food, and precious metals arenas.

We'll be back with technical updates on gold, the dollar, and commodities in a bit.

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Kotick on Gold's Potential

Not to be viewed as a positive sign of things to come, as we've long discussed, gold appears to be set to make a larger move. Here is a similar take from Jordan Kotick at Barclays Capital, of frequent CNBC fame.

Our target at this point is not as aggressive as Jordan's, with $1300 being the target based on the current pattern. At that stage, we'll reevaluate the market conditions and make another forecast. Since we are of the belief that the DJIA/Gold ratio will approach 1:1, it will be important to take into account other market conditions to make further projections.

Many analysts are talking about $5,000+ gold. That remains to be seen, and is highly dependent on inflation and/or fear of government actions to come. Gold is the currency of last resort.



Gold, ‘Off The Charts’, May Target $1,500: Technical Analysis
By Glenys Sim

Oct. 7 (Bloomberg) -- Investors should hold onto long positions in gold as bullion has “significant upside potential” to reach as high as $1,500 an ounce, Barclays Capital said, citing trading patterns.

“Having rallied ‘off the charts’, we are left to resort to projections and extrapolated trendlines to forecast where the move might stop,” Jordan Kotick, global head of technical analysis at Barclays Capital, wrote in a note e-mailed today.

So-called trendlines are used to determine momentum and are found by connecting an asset’s high prices and low prices over a given period to form a channel.

“Channel resistance currently is at $1,370; history suggests a run at $1,500,” Kotick wrote. “Taking it a step at a time, in the coming weeks, we view consolidation above $1,020 as extremely positive, targeting $1,050 initially, and $1,120,” he added.

Gold for immediate delivery gained as much as 2.6 percent to a record $1,043.78 an ounce yesterday, and traded at $1,038.46 at 10:35 a.m. in Singapore.

“We suspect the rally is wave 3 of 5, indicating an eventual push toward the $1,120 area and potentially beyond into year end,” wrote Kotick, referring to the Elliott Wave theory, which holds that market swings follow a predictable five-stage pattern of three steps forward, two steps back.

“Initial resistance is found in the $1,050 area but that is way too conservative given the springboard that a wide 18- month range provides,” he added.

Not Unstoppable

To be sure, when compared against the major currencies, it’s clear that the gold rally is “by no means unstoppable, as none of the charts show prices concurrently pressing against their respective all-time highs,” Kotick said.

Gold priced in euros, pounds, South African rand, Australia and New Zealand dollars hit records in February as investors turned to bullion as a hedge against weakening currencies. Gold reached a peak of 783.87 euros and 692.66 pounds on Feb. 18.

“Against sterling, gold is making great strides, and against the euro it is breaking higher out of range, but against the yen it is holding in a well-defined range,” said Kotick. “These charts speak volumes: as much about currency perceptions as the value of gold.”

To contact the reporter on this story: Glenys Sim in Singapore at Gsim4@bloomberg.net

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The Economic Downturn is Not Over

Interesting video clips from the Yahoo! Tech Ticker summarizing the bears coming out against the stock market.  Roubini, Soros, Faber, Rogers, Stiglitz, and many others are predicting a downturn--at some point.

From a trading perspective, we have to respect that the bulls have been in charge of stock market prices and go with the trend until that trend changes.  We can see the inverse correlation between the dollar and the stock market.  Obviously, that correlation has to end at some point if our thesis of a lower dollar and weaker stock market come to fruition.  We're not sure when that may be, but it will be an important part of this economic cycle.

It's a question of "when," not "if."






Roubini Sees Stock Declines as Soros Warns on Economy

Oct. 5 (Bloomberg) -- New York University Professor Nouriel Roubini said stock markets may drop and billionaire George Soros warned the “bankrupt” U.S. banking system will hamper its economy, highlighting doubts about the sustainability of the global recovery.

“Markets have gone up too much, too soon, too fast,” Roubini, who accurately predicted the financial crisis, said in an interview in Istanbul on Oct. 3. U.S. stocks may suffer a “major decline” after climbing to the highest levels in almost a year two weeks ago, according to technical analyst Robert Prechter, founder of Elliott Wave International Inc.

Stocks have surged around the world in the past six months as evidence mounts that the economy is emerging from its deepest recession since the 1930s. The Standard & Poor’s 500 Index has soared 51 percent from a 12-year low in March while Europe’s Dow Jones Stoxx 600 is up 48 percent. The euphoria contrasts with warnings from policy makers and investors like Soros, who said today that the U.S. economic recovery will be “very slow.”

U.S. consumers are “overdebted” and the country’s banking system has been “basically bankrupt,” Soros said in Istanbul today. “The United States has a long way to go.”

Group of Seven finance ministers and central bankers also struck a cautious tone after meeting on the shores of the Bosporus over the weekend, saying the prospects for growth “remain fragile.”

‘Barely Recovering’

“The real economy is barely recovering while markets are going this way,” Roubini said. “I see the risk of a correction, especially when the markets now realize that the recovery is not rapid and V-shaped, but more like U-shaped. That might be in the fourth quarter or the first quarter of next year.”

U.S. and European stocks gained today after reports showed service industries expanded on both sides of the Atlantic.

“Stocks are very overvalued,” Prechter, who advised betting against U.S. equities three months before the market peaked in October 2007, said in an Oct. 1 telephone interview. “Stocks peaked in September and are back in a bear market.”

The S&P 500 will probably fall “substantially below” 676.53, the 12-year low reached on March 9, he said. His projection implies a drop of more than 34 percent from last week’s close of 1025.21. It rose to 1031.77 at 10:05 a.m. in New York.

Valuations

Gains in the index have pushed valuations to more than 19 times reported operating profits from the past year, data compiled by Bloomberg show. That’s near the most expensive level since 2004.

U.S. stocks fell last week after manufacturing expanded less than anticipated and unemployment climbed to a 26-year high of 9.8 percent. In the 16-nation euro region, the jobless rate is at 9.6 percent, the highest in more than a decade.

HSBC Holdings Plc Chief Executive Officer Michael Geoghegan fears there will be a second global economic slump, the Financial Times reported today, citing an interview. Geoghegan forecast a W-shaped recovery and said the “reality is that profits will be quite reduced,” the newspaper reported.

The International Monetary Fund predicts the global economy will expand 3.1 percent in 2010, led by growth in Asia, after a 1.1 percent contraction this year. That is still “anemic” and “very weak,” Roubini said.

If growth doesn’t rebound rapidly, “eventually markets are going to flatten out and correct to valuations that are justified,” he said. “I see a growing gap between what markets are doing and the weaker real economic activities.”

Creating Bubbles

Stocks will continue to advance, according to Byron Wien, vice chairman of Blackstone Group LP. The S&P 500 is poised for its biggest fourth-quarter rally in a decade as the economy recovers and earnings exceed analysts’ forecasts, Wien said in an interview on Sept. 28.

The global equity rally has added about $20.1 trillion to the value of stocks worldwide since this year’s low on March 9. Governments have poured about $2 trillion of stimulus into the global economy while central banks have cut interest rates to close to zero in efforts to revive growth.

“In the short run we need monetary and fiscal stimulus to avoid another tipping point and to avoid deflation, but now this easy money has already started to create asset bubbles in equities, commodities, credit and emerging markets,” Roubini said. “For the sake of achieving growth stability again and avoiding deflation, we may be planting the seeds of the next cycle of financial instability.”

To contact the reporters on this story: Shamim Adam in Istanbul at sadam2@bloomberg.net; Francine Lacqua in Istanbul at flacqua@bloomberg.net

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It's Getting Serious

Generally speaking, we try to offer information for people seeking to understand what's happening in the world and how to protect what they have in these perilous times.  Our position is simple: the US, and parts of Europe, are in the early stages of an inflationary depression.  Asia, assuming they focus on being less reliant on the US and Europe as customers, are in a recession.  The dollar, as reserve currency of the world, is in trouble due to profligate spending and overextension.  We are in a period where we will revert back to more equilibrium in the world, and the transition will be very painful.  It is likely that many will lose everything in this transition, which will take a decade or so to play out.  The transition time may include wars, starvation, and most certainly increased government oppression around the world.

We use the technicals to help navigate the financial storm, but the reality is that over time, holders of most fiat currencies are in trouble, notably Americans.  As we enter a time of incredible strife and conflict, it will be imperative that intelligent people spend time preparing for what's to come.  Food, water, energy, clothing, shelter and protection should be the key focus for people just starting out.  Have several months worth of living expenses in cash.  After that, just note that cash in all of its fiat forms is being destroyed through the actions of banks and the government.


Gold is, in our opinion, the single best protection in this environment--physical gold in your possession.  After that, the goal should be either to diversify assets into things that are guaranteed to hold value (tangible assets) or to take appropriate risks for capitalizing on the chaos that will ensue.  Yes, it sounds terrible to capitalize on destruction, but the destruction is going to occur whether you capitalize on it or not.  You can either benefit from it or suffer from it.  That is a personal choice.

Yesterday, we wrote a piece on currencies and inflation.  Last night, we reported on the breakdown that in the dollar and its imminent test of support at 76.  We've reported many times that there's not much support for the dollar between 78 and 72, with the exception of minor support at 76.  We have touched and bounced off of 76, consolidated, and last night we reported that we would test 76 this week again, and that gold would break through its resistance at 1020.  We didn't know it would happen quite that fast, but it occurred today.

We're at an important stage.  A drop from 76 to 72 in the USDX is a major drop.  Asset prices will rise quickly in response.  The 72 range is a critical range.  If the dollar breaks down below 72, the risks are substantial. 

If you own no physical gold at all, you should consider purchasing some on any pullback.  Email us if you'd like the names of some possible suppliers--we have no affiliation with them other than being customers ourselves. 

We will be watching the 76 closely and reporting on it.  Gold will react opposite the dollar.  It may lead the move, but gold will not truly take off until the 76 level is broken through.  That may happen at any time.  You can see the inverse correlation between dollar-based asset prices (including gold) and the dollar itself.  Stocks today have shot up on lousy fundamentals as the dollar has taken a dive in overnight trading.  This is a serious time.

More on gold, the dollar, and gold stocks later today.

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