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With All Markets Trading in Tandem, Why a Reversal Might Be on Tap

|Includes:EUO, GLD, ProShares UltraShort S&P 500 ETF (SDS), SLV, UUP

 Happy Groundhog Day!  And don't try telling me otherwise - at least as far as the markets are concerned.  Everyday the S&P 500 creeps higher - as does gold, silver, and what the hell, even the Euro!  Is Punxsutawney Phil nearby?

Let's start with the S&P, which has bounced several times off the 1040 mark, and has been climbing a staircase to heaven for the entire (traditionally bearish) month of September:

S&P 500 Price Chart September 2010

Source: StockCharts.com

Correlation of stocks is at a multi-decade high, while volume remains non-existent (Labor Day did happen...right?) - but us bears have thus far been foiled on any potential short trades.

Meanwhile, the price action in gold and silver has been even more bullish - there's no mistaking these moves:

silver price chart september 2010

gold price chart september 2010Source: StockCharts.com

Sure the explanation for these moves seems perfectly valid and logical - that soverign debts will be monetized as countries engage in a game of competitive devaluation.  Which will, of course, reward "real money" like gold and silver.

And perhaps it will.  But I'm with our hero Hugh Hendry, who thinks we've got a few chapters to be played out before the logical conclusion of this story comes to fruition.

Signaling that the "reflation trade" is back on, even the Euro has been joining the "anything but the dollar" party!

euro price chart september 2010

I'm unsure on what exactly has improved in the Euro's fundamentals since the June lows.  Credit spreads are breaking out once again on Greek sovereign debt.  And more importantly, as our astute reader and correspondent Dr. Evil wrote to me a few weeks ago, the real linchpin is Italy.  As the good doctor reported, it's not a matter of IF Italy will need to restructure, but WHEN - and that will be the huge domino to topple for Europe.

Over the last few months, sentiment on the Euro has swung from VERY bearish, to VERY bullish.

Meanwhile the bastard stepchild not invited to this roaring campfire of a good time is the US Dollar.  The buck, a favorite of deflationists around the world (all 12 of us?), has been getting taken to the woodshed as these rallies have been occurring:

 us dollar forex price chart september 2010

 

Since we've got extreme bullish sentiment on everything except the dollar, and extreme bearish sentiment on the dollar, I'm going to say we're due for at least a short term return to the Deflation trade.  Even if gold and silver are heading to the moon, markets don't trade in a straight line, and extreme bullish sentiment usually results in at least a short term pullback/correction.

If the dollar does manage to stage a rally, it'd likely coincide with some carnage in all other asset classes.  The extent and length of this carnage remains to be seen - as does the government's reaction to this overdue sell-off.

Get your popcorn ready - things have been calm for awhile.  We've got some setups indicating things are about to get a little more interesting!



Disclosure: Short the S&P 500
Stocks: SDS, UUP, EUO, GLD, SLV