What Does the Dollar Bottom Mean for Stocks and Commodities?

Many markets are hinting that they are approaching critical mass and look primed for major reversals. I’ll start with the dollar. I think it is interesting has the dollar has bee all but written off; ever since the first rate cut inflation became a fear, then China came out and questioned the dollar’s reserve statue, then Russia, now Buffett, the Oracle himself has now publicly written that the dollar faces major inflationary pressure. There have been extreme low readings in bullish sentiment in the dollar. If anyone had any propensity to sell the dollar, they have had many scary sounding reasons to do so and probably have done so at this point. However, I think that has essentially loaded everyone on one side of the trade, a necessary ingredient for a major reversal that will catch almost everyone off guard.

So what do the charts say:

What stands out is the bullish divergence in price as it approaches long term support. It is very clear the that dollar made new lows, but that momentum indicators are in fact making clear higher lows, even flirting with the bullish 50% mark. Volume is also starting to peak after a long period of lows volumes, another trademark sign of a trend ending, and a new trend beginning. I think what is also very telling is the bearish sentiment in the dollar, which some polling services say equals the bearish reading on stocks in early March. Again, if you had any propensity to sell, or short the dollar, you have done so.

In terms of intra market analysis, I think we can get confirmations by looking at other inflation trading vehicles such as silver and gold. If you were a bull on gold, almost everything you have wanted to occur has happened, but gold has refused to breach its all time highs. The world almost ended, dollar inflation seems ordained, yet here we are under 1000. Furthermore, the charts are revealing the first signs of real weakness in gold’s dollar correlation.

Again, the world almost ended, the dollar is preordained to be worthless, dogs and cats are living together, mass hysteria, etc. We can clearly see to lower highs in gold while the dollar rolls over and sets lower lows. The correlation breakdown is very suggestive that the precious metals are very over owned or the dollar is very oversold… or both. If the dollar starts an up-trend, based on the height of this congestion pattern, gold could plummet 15% or more. I know that 15% is even greater than the first target suggested by the height of this pattern, but anything that trades in the futures market is known for taking the stairs up… but the window down.

So let’s also take a look at silver, which again paints a very similar picture to gold.

You can see that despite new highs, silver has had declining momentum that continues downward. I would note the trend line break and the sideways congestive action. The failure to make higher highs while the dollar is making lower lows just plain old smells over bought and primed for a fall. Lastly, I would mention sentiment again. Silver bulls are popping up all over, and are hypnotized by all the money they are going to make when the dollar goes under and silver goes to infinity. You might not believe in technical analysis; however, commodities are dollar denominated. It’s a simple mathematical relationship that when the dollar goes down, silver goes up. If that is not happening, that should be a red flag, and thus far that has kind of been under the radar of the mainstream media.

In terms of what is going on in the stock market, I would say that the biggest predictive statistic is again the supreme sense of optimism that currently permeates the markets and business media. Many polling services are reporting bullish sentiment that is greater or equal to conditions back in October 2007, when the stock market had a major peak. I would also note the inverse relationship between the dollar and stocks, and that the extreme low reading in bullish sentiment in the dollar is quite bearish for stocks. Volumes have also been consistently falling, while by itself not an action signal, generally a negative, and possibly a sign that supply of buyers is falling, and the supply of potential sellers has now been recharged.

Lastly, they say history doesn’t repeat, it rhymes. The 1929 period and the 1930 corrective rally have almost striking parallels to the rally we have been experiencing in terms of length of time, retracement, and percent gain. The highest probability retracement zone for either Dow Theory or Fibonacci has now been achieved. One can argue whether the lows have been set, whether the market will go lower, or just needs more time to heal, however, all the ingredients of a major top and reversal are now in place, the table has been set, the porridge out, and the bears will soon be back.

Disclosures: Long SPY puts.

Comments

[Roger Knights:]

Bingo! It looks like we'll get a one-day reversal today.

"I would say that the biggest predictive statistic is again the supreme sense of optimism that currently permeates the markets and business media."

The top is in; the cover story of Business Week's special issue last Monday was, "The Case for Optimism."

Aug 24 02:06 PM

[ManAboutDallas:]

Sorry, nothing more coming for the $ than a butter-the-chumps rally before the Plunge IntoThe Abyss that'll take out the .72 low like a hot knife through butter on the way to .50. If it's luckier than it has any right to be, we'll struggle back to just under .80 which is the .618 Fibo of the June-Aug drop.

The US$ is T - O - A - S - T.

Aug 24 02:15 PM

[ManAboutDallas:]

Might have one last lunge left up to about 10,334 which is the 50% Fibo of the October 2007 all-time top and the March 2009 panic low. If 9422 ( 38.2% Fibo ) gives way, Katy bar the door, that's all she wrote.


On Aug 24 02:06 PM Roger Knights wrote:

> Bingo! It looks like we'll get a one-day reversal today.
>
> "I would say that the biggest predictive statistic is again the supreme
> sense of optimism that currently permeates the markets and business
> media."
>
> The top is in; the cover story of Business Week's special issue last
> Monday was, "The Case for Optimism."

Aug 24 02:19 PM

[LT Trader:]

I'm also in the dollar bullish camp over the past week. Too much pessimism, ala the stock market in early March. Investors forget that the financial crunch is world-wide and countries in Europe also have their own issues. It's a currency devaluation race to the bottom, and perhaps the U.S. won't lose. Expect the US$ strength to pose risk to US equities.

Aug 24 02:43 PM

[ManAboutDallas:]

The US$ is absolutely, positively guaranteed to be the biggest loser in the race to the bottom, because as the current reserve currency, it has the MOST to lose, as such.

It's the basic Law Of The Jungle: everybody wants to knock off the King, as soon as the King shows the signs of fatal vulnerability.

And with the US$ being held up by nothing but lies and posturing, the final chapter is already written. And it's not pretty.




On Aug 24 02:43 PM LT Trader wrote:

>. It's a currency devaluation race to the bottom,
> and perhaps the U.S. won't lose.

Aug 24 02:59 PM

[GMiki1:]

Weak dollar/strong dollar doesn't really matter. It's what can you buy with it. If you want to preserve your buying power, go gold and silver.

Aug 24 03:31 PM

[BlackyBlack:]

The dollar will go back up when the next crisis hits.

Aug 24 04:17 PM

[William Occam:]

I agree with you analysis, but I'm more impressed by your witty prose. Thank you. I tire of reading good analysis tarred by stilted writing, and so I look forward to more posts.

Aug 24 07:00 PM

[Bill L.:]

Thanks all for you comments, I hope you enjoyed the read. Overall all assets are moving with a unnaturally very high degree of correlation, what this means unfortunately, that if the dollar begins to rally, that will spell the end of the rally in stocks and most commodities. Watch the dollar carefully because the media will miss it and say the correction is due to some news that traders will focus on that day. It will be the stealth rally in the dollar that leads us lower, so watch it carefully as a warning on when we correct, and how far down we go.

Aug 24 09:31 PM

[williemo:]

excellent analysis.
sort of like a cool spell in the middle of the summer......no one expects it........but the weather forcaster says it's coming. if you're on a trip w/o your jacket, it will be uncomfortable........sort of like the next couple of months for gold and silver. However, I do feel the heat will come back, ie, metals will return as the Obama reign continue to keep money supply strong, to save his political a.........

Aug 25 10:33 AM