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December 28, 2009

Happy New Year

The corrective rally in the U.S. Dollar is playing out almost as anticipated thus far. The dollar spiked powerfully off its low and is now in week five of what I predicted would be a 6-8 week affair. The last few sessions have seen minor weakness on the DX, and as described a few days ago, I expect this pull-back to stretch through year-end. We should then see another 2-3 weeks of dollar strength to complete the corrective move and test the 200DMA.

us dollar index daily chart

The market could certainly trap a lot of people if the DX were to pull back more fervently this week. Dollar bears would pile on USD currency shorts. Gold bugs would feel compelled to follow what is likely to be a quick snap higher in the price of our little yellow friend, and equity bulls would tout the coil breakouts and weaker dollar as the start of a fresh leg higher in this mother of all rallies.

I suspect each party will be disappointed as the new year begins and the buck starts its second leg higher. Which brings us to the word "almost," used above to describe how the game was playing out versus expectations. The one key aspect of this countertrend rally which has played hooky, so to speak, is a correction in equities. Now, I do not believe a paradigm shift has evolved in the inverse relationship between stock and the buck. The recent anomaly is a product of market psychology and seasonality. When the dollar shifted gears, the gold market was saturated with long plays, and so the metal's price reacted easily to the shift in the dollar's short-term trend. Equities, on the other hand, continue to be the target of naysayers and skittish bears who short every hiccup. These people are being bathed in their own blood. Eventually, a seasonally thin market became an easy environment for the big fish to induce mini short-squeezes and unload to the bulls mentioned in the last paragraph (evidenced by all the selling-on-strength data posted in the WSJ this month).

Those bulls, in my opinion, are close to having the trap door unlocked beneath them. When the second leg of the dollar rally takes hold, I expect stocks to drop hard. In the 2-3 weeks it takes the buck to complete its move, equities should suffer the full extent of the decline we expected over the entire 6-8 week move. In my opinion, that decline could reach the SPX 950 pivot.

s&p 500 daily chart

The timing is perfect for those mendacious market gods to pull the rug out because if this week (year) ends on a high note, what weak-handed bear is going to risk holding over a long weekend into the first days of a new year? Not only does the market lull bulls into a false sense of security, but it traps bears, who are sitting on massive losses, out of their positions!

As for precious metals, I do not expect the powerful part of this run to begin until we are within a few days of the end of the dollar rally. Will the metals set new lows for the correction? I hope so! I want to load up on the cheap. But there is nothing to do right now except wait for these moves to play out or for the market to prove the outlook incorrect. Either way, we are in thumb-twiddling mode, so unless something dramatic happens before the weekend, this will be the last post of the year.

Happy New Year to all.


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