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August 2, 2009

Breaking the Buck

Early this week I beefed up my silver position in anticipation of an imminent break higher in precious metals. I was rewarded with an immediate break lower to the tune of nearly 6%. Rather than panic and close, I decided to wait an see how the dollar would finish the week and month. On Friday, the market gods betrayed their hand:

dollar index chart

It appears the fifth wave down off the March high will not truncate at the wave 3 low. We should now see the dollar index retreat at least to the 74 pivot... and perhaps as far as the 2008 low... before rolling into a larger corrective move. Such a move should send precious metals into the breakout move we bulls desire.

Here is where I will depart from conventional wisdom: I do not think a further drop in the buck is necessarily bullish for stocks. For one, a major breakdown in the dollar could induce a flight from dollar-based assets, including U.S. stocks. Second, I expect another round of economic crisis to unfold, whether it be more major banks in trouble or soaring Treasury rates. A crisis could escort stocks rapidly lower simultaneously with a flight from the dollar. I've stated before that when the next round of crisis hits, the safe haven play will not be bonds, but rather precious metals.

Furthermore, one aspect of this market that is patently clear in retrospect is the fact that everyone and his brother had been either hunting for or wary of an end to this rally throughout most of June and July. Most of these naysayers, including yours truly, expressed doubt that the S&P 500 would manage to conquer 950. It is an axiom of trading that the market will do what it can to deceive the majority of participants, and so the market went up and heartily busted SPX 950. I've now noticed a distinct shift in outlook among prognosticators, with many calling for SPX 1025-1050 as a foregone event. I did the same not two weeks ago. Would it not be the height of cruelty for the market to slip into bear mode without even a close above SPX 1000?

Consider that several of our favorite oscillators (Advance-Decline Volume, McClellan Oscillator) are now sporting overbought readings that have previously coincided with market tops, and we have the makings of a surprise decline. Also, the move from SPX 875 looks as much like an ending move as it does a breakout... more so like an ending move, actually, since volume has not been very supportive of the idea of a major move higher. In fact, a reversal day on monster volume may seal the deal on this one. Let's wait and see.

One word of caution: fighting the Fed is a game wrought with hazards. If you decide to short equities, caution is warranted and is best exercised via diminutive position sizes. I'm traveling tomorrow. See you later in the week.

Addendum: Here are a few charts I wanted to add yesterday, but didn't have time.

stock market indicator

stock market indicator

stock market indicator

Despite index futures being strong overnight, I don't think any rally from here can be sustained. That's not to say we won't see a sharp move to shake out bears, but I am on alert for a reversal day on volume to confirm and end to the rally. Right now I have a modest short position to express this view and also to hedge my silver position against any surprises.


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