Bret Rosenthal's  Instablog

Credit markets are showing strength and stability while equities swoon. This divergence usually leads to a great buying opportunity in equities. Historically (since 2007), credit market behavior has been the single best leading indicator of equity and commodity prices.

So, here we are again in the midst of an October sell off and the question on every investors mind is the typical "will this be the beginning of a real market decline". The answer to this conundrum often gets overly confusing when one mixes the lethal combination of CNBC commentary, Wall St. Journal stories and political hype. However, the riddle can best be attacked when using just two simple factors. Allow the noise to die away and join me for a comfortable cruise on the river of reality.

Simple Factor Number 1: Credit

Rosenthal Investing Axiom: If credit markets are stable and or getting tighter (positive) then equity market weakness can be discounted. Look for buying opportunities in equities if this divergence persists.

MJ Credit Guru: 10/25/12 - The CDX IG19 Index flirted with the idea of trading through 100bps before stabilizing. The index is trading tighter this morning, and we remain convinced that the index is not going to trade wider than 100bps unless the market is forced to deal with an "unexpected event that causes systematic risk" to increase. This is why we believe a weak corporate earnings season could cause us to trade below 1400 (S&P 500), but only marginally below 1400, and only for a short period of time. The lack of a "negative systematically important trend" makes it unlikely that corporate investors are going to want to pay high short carry costs or that banks will walk away from fees associated with financing distressed companies or high leveraged companies.

Simple Factor Number 2: The US Dollar

Rosenthal Investing Axiom: US$ direction leads equities / commodities. Study and understand the price chart of the US$ and you will have solid insight into the direction of risk assets.

For proof of this Axioms validity, look no further than our August 3rd Post titled, "The U.S. Dollar: A Classic Breakdown in Price" This post outlined in detail the pending breakdown in the US$ and explained the positive correlation for commodities and equities. August and September turned out to be great months for risk assets as prophesied.

A look at the price chart of the US$ ETF (UUP) now may again be helpful. This time we will try to gauge the strength and severity of this most recent equity / commodity sell off…

(click to enlarge)

As you can see above, the breakdown from the August high reached a low of $21.60 in September and the US$ has since traded in a sideways range. This sideways volatility between $21.60 and $22.00 has led to confused trading for risk assets. And the recent surge in UUP up to the resistance area highlighted for your convenience in yellow has drive the various equity indices down to key areas of support.

To conclude, the picture today is not as crystal clear when analyzing the US$ behavior as it was in early August. However, I feel comfortable going out of a limb and saying that if Credit markets continue to evidence signs of strength and stability then I don't believe the US$ (UUP) will break above the key $22.00 area of resistance. The resistance area is the confluence of three key analytic tools: The strong downward trending 50 day moving average (thin Black line), the downtrend line in place since the August high (red line), and the top of the recent consolidation range (black line).

We will continue to monitor the credit markets and the US$ and update our thinking here when the need arises. Should you wish for more acute analysis please feel free to follow me on twitter https://twitter.com/BretRosenthal

We covered in detail the coming breakdown of the US$ in our August 3rd post titled, "The U.S. Dollar: A Classic Breakdown in Price". Since that post the US$ has suffered and the suffering has accelerated in recent weeks. Of course, consequently Gold and Silver experienced renewed strength and broke out of year long down trends.

Never before has there been such a clear indication that technical analysis deserves respect as a tool when interpreting the markets. On August 3rd we saw a clear change in direction of trend for the US$ but the fundamentals were still cloudy. Today, after more than a month long decline in the US$ we now enjoy a clearer view fundamentally for the U.S. Dollar's current and continued weakness. Allow me to expound:

- From August 29th 2011 through August 2nd 2012 the US$ offered a beacon of safety in a world mired in sovereign debt confusion. The collapse of the European sovereign debt markets forced financial institutions to hide excess capital (of which there is an ever increasing amount) in US Treasuries. Thus the exodus out of Euro area bonds into US debt led to what I would call artificial support for the US$. Artificial because anyone with a brain can see the economic situation in the US does not merit enthusiasm. This trade out of Euro area debt into US debt was simply chair shuffling on the deck. Lest we forget that fund managers far and wide were front running said debt trade exacerbating the artificial support for the US$.

As of August the 3rd 2012 the tables have turned. The massive short position in Euros / Long US$ trade is unraveling. Mario Dragi's recent speech detailing the ECB's unlimited support for European sovereign debt effectively put an end to the flow of funds out of Europe into the US. Now fund managers are scrambling to unwind their short Euro position while banks all across Europe repatriate. The artificial US$ trade built to a massive amount over a 12 month period and the unwind will be equally if not more powerful going forward.

Precious Metals prices suffered through 12 months of strong US$ head winds while this European debt crisis and US$ trade unfolded. Now in the first month or so of the US$ unwind Gold jumps over 10% and Silver 28%. I ask you to imagine the level at which Gold and Silver would be trading had artificial support for the US$ not interrupted the ascent of 2011.

- Add to the unwind process described above the recent US Fed Chairman's comments about another round of quantitative easing and you will have a recipe for a dramatically weaker US$ on a go forward basis. Fed chair Ben Bernanke announced QE3 yesterday and the following takeaways create a sense of euphoria for a Precious Metals Bull:

-QE3 will be unlimited

-QE3 will start with $40 billion per month and rise from there if economic numbers don't improve in the next couple of months

-QE3 will continue even after economic numbers improve to ensure growth is sustainable

-Upon direct examination by reporters Ben stated (not verbatim) the mandate of employment is more important than fighting inflation and so the Fed will tolerate a higher number on inflation to ensure job growth.

In conclusion, those of you who have been a part of Rosenthal Capital Management for the last 6+ years will recognize the above statements by the Fed as an inevitability not a surprise. Gary and I have attempted to educate and inform over the last 6+years that unlimited QE was the natural evolution of Fed policy. We have championed the philosophy that evermore aggressive currency debasement will lead to sustained moves higher in Gold and Silver prices. After a 12 month rest, prepare for said moves higher to accelerate.

If for some reason the comments and actions of the US Fed and The ECB were not enough of a reason to compel the swarming of Gold / Silver trading pits please read the following story. You will find that China and Russia are tightening the noose around the neck of US$ bulls.

© TIME/Facts Global Energy

On Sept. 11, Pastor Lindsey Williams, former minister to the global oil companies during the building of the Alaskan pipeline, announced the most significant event to affect the U.S. dollar since its inception as a currency. For the first time since the 1970′s, when Henry Kissenger forged a trade agreement with the Royal house of Saud to sell oil using only U.S. dollars, China announced its intention to bypass the dollar for global oil customers and began selling the commodity using their own currency.

Comment: Lindsey Williams: "The most significant day in the history of the American dollar, since its inception, happened on Thursday, Sept. 6. On that day, something took place that is going to affect your life, your family, your dinner table more than you can possibly imagine."

"On Thursday, Sept. 6… just a few days ago, China made the official announcement. China said on that day, our banking system is ready, all of our communication systems are ready, all of the transfer systems are ready, and as of that day, Thursday, Sept. 6, any nation in the world that wishes from this point on, to buy, sell, or trade crude oil, can do using the Chinese currency, not the American dollar. - Interview with Natty Bumpo on the Just Measures Radio network, Sept. 11

This announcement by China is one of the most significant sea changes in the global economic and monetary systems, but was barely reported on due to its announcement taking place during the Democratic convention last week. The ramifications of this new action are vast, and could very well be the catalyst that brings down the dollar as the global reserve currency, and change the entire landscape of how the world purchases energy.

Ironically, since Sept. 6, the U.S. dollar has fallen from 81.467 on the index to today's price of 79.73. While analysts will focus on actions taking place in the Eurozone, and expected easing signals from the Federal Reserve on Thursday regarding the fall of the dollar, it is not coincidence that the dollar began to lose strength on the very day of China's announcement.

Since China is not a natural oil producing nation, the question most people will ask is how will the Asian economic power get enough oil to affect dollar hegemony? That question was also answered by Lindsey Williams when he pointed out a new trade agreement that was signed on Sept. 7 between China and Russia, in which the Russian Federation agreed to sell oil to China in any and all amounts they desired.

Comment: Lindsey Williams: "This has never happened in the history of crude oil. Since crude oil became the motivating force behind our (U.S.) entire economy, and everything in our lives revolves around crude oil. And since crude oil became the motivating factor behind our economy… never, ever has crude oil been sold, bought, traded, in any country in the world, without using the American dollar."

"Crude oil is the standard currency of the world. Not the Yen, not the Pound, not the Dollar. More money is transferred around the world in crude oil than in any other product."

"On Friday, Sept. 7, Russia announced, that as of today, we will supply China with all of the crude oil that they need, no matter how much they want… there is no limit. And Russia will not sell or trade this crude oil to China using the American dollar." -Interview with Natty Bumpo on the Just Measures Radio network, Sept. 11

These duo actions by the two most powerful adversaries of the U.S. economy and empire, have now joined in to make a move to attack the primary economic stronghold that keeps America as the most powerful economic superpower. Once the majority of the world begins to bypass the dollar, and purchase oil in other currencies, then the full weight of our debt and diminished manufacturing structure will come crashing down on the American people.

This new agreement between Russia and China also has serious ramifications in regards to Iran, and the rest of the Middle East. No longer will U.S. sanctions against Iran have a measurable affect, as the rogue nation can simply choose to sell its oil to China, and receive Yuan in return, and use that currency to trade for the necessary resources it needs to sustain its economy and nuclear programs.

The world changed last week, and there was nary a word spoken by Wall Street or by politicians who reveled in their own magnificence as this event took place during the party conventions. A major blow was done on Sept. 6 to the American empire, and to the power of the U.S. dollar as the world's reserve currency. And China, along with Russia, are now aiming to become the controllers of energy, and thus, controllers of a new petro-currency.

It is rare in the business of Technical Analysis to uncover a price chart that offers an almost flawless indication of price direction. However, as I write this missive today I find myself staring in virtual disbelief at the daily price chart of UUP (The U.S.$ ETF) and believe I have uncovered one such gem.

Technical analysis is often maligned as more of an art form than a strict replicable discipline, but of course there in lies the beauty. If you happen to be a bit of an artist and dedicate yourself to the pursuit, as I have for over 25 years, then perhaps you can get an edge. Of course, this type of analysis (identifying price chart patterns) does not guarantee precise movement but instead increases the odds of success for a particular outcome.

Please review the chart below of UUP and meet me on the other side for an explanation…

As your docent, if you will, I would begin by drawing your attention to the grey rectangles that appear on the UUP chart at the beginning of June. At the top of the graph you will see the initial top in price reached on May 31st/June 1st. Then if you glance below the Price graph to the three Momentum graphs (DMI, MACD, Stochastics) you will witness classic momentum sell signals across the board highlighted for your convenience in corresponding grey rectangles.

Now, please allow your eye to wander further to the right of this masterpiece and pick up the yellow rectangles. The rectangles at the top show consecutive new highs in price of UUP while the rectangles below illustrate clear non-confirmation of the price highs. The yellow momentum rectangles at the bottom right show disturbing lower highs suggesting that while the price of UUP wandered into new high ground a major lack of conviction was building. This weakness resulted in the subsequent gap down of July 26th to the red uptrend line. Finally, one can see that as the price ran up to "close" the gap (Red circle) the momentum was dismal (Red circle on Stocastics) leading again to today's vivid breakdown below the red uptrend line. The top is now complete and a new trend, likely down, is in place.

Precious Metals Outlook:

Should this U.S.$ breakdown continue to unfold, as the analysis suggests, then there will be no greater beneficiary than the commodity markets and more precisely Gold and Silver prices. In fact, analysis of the price and momentum action of the Gold market reveals an almost mirror image of the U.S.$ chart above. Higher lows have been in place for the Gold market since the June 1st top in the U.S.$ creating a clear uptrend and a tidal wave of positive momentum has been building . I will reveal a thorough analysis of the Gold market in a future post, but for now begin to wrap your head around the likelihood of a major directional shift in Gold prices after a 12 month price consolidation.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.