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February 10, 2006

Forced Hand

What initially looked like a rout on Wall Street quickly turned into rally mode this morning, forcing a lot of bears on their heels. After falling sharply for the first hour and a half of trading, stocks turned on a dime and went steadily up the rest of the day. Despite my belief that we are in the midst of a serious downswing in equities, today's reversal forced me to reduce my short exposure. No matter how strong the belief, a trader can never presume to be correct. For the sake of capital preservation, prudence requires attention to market signals, especially when they indicate that one's short-term assumptions may be incorrect.

The dollar also experienced a reversal today, with the dollar index closing fractionally higher after being down a half point in the early going. Even 10-year Treasuries underwent a change in fortune today, but ironically, to the downside. A look at 10-year bonds, as represented by TLT, shows the failure of the October rally, where former support has become resistance, as well as the longer-term trend break that occurred last fall. The RSI also shows us a longer term loss of momentum.

stock chart

We are presented with the likelihood of a test of support around 87. If we are to test... or even fail... support at 87, there would be some serious pressure on the dollar. The Fed will be tempted to continue raising rates at that point to defend our currency, but would be doing so under duress. Economic pressures from a slowing housing market will likely override those temptations.

Metals continued their highly volatile journey by giving up all of yesterday's 3% gains. Both gold and silver were down sharply, even while the dollar was tanking this morning. The dynamics in the currencies, both real and fiat, would suggest traders are factoring in a longer tightening cycle than previously anticipated. The fears may spawn from Sir Alan's recent note that the Fed has a lot of unfinished work to do. But these are the words of a politician who has a long history of trying to prop markets with words. More likely than not, the current action is simply setting up another fabulous buying opportunity in metals.

Disclosure: None


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