MARKET PULLS BACK FROM SHORT-TERM OVERBOUGHT CONDITION -- CRB INDEX HITS 23-YEAR HIGH -- FALLING DOLLAR IS DRIVING MONEY TO FOREIGN COMMODITY PRODUCERS

BEAR MARKET IN DOLLAR CREATED BULL MARKET IN COMMODITIES... A weak September jobs report pushed the U.S. dollar sharply lower today. The dollar drop pushed gold to a six-month high and boosted gold shares which were the day's strongest market group. The dollar bear market is nothing new. It's been going on for more more than two and half years. And it's set in motion some trends -- both domestic and international -- that are still continuing today. I wrote a recent piece that talked about a dual impact of the falling dollar. One was that it's been driving money into foreign markets. That's still happening. The other result of the falling dollar has been rising commodity markets. Chart 1 shows the CRB Index bottoming at the start of 2002 (see green circle) and beginning the strongest bull market since the 1970s. Chart 2 shows that the early 2002 commodity bottom coincided with a major peak in the U.S. Dollar Index (see red circle). Today's dollar weakness help push the CRB Index to a new twenty-year high. That's been a boon to basic material and natural resource stocks that are tied to rising commodities.

Chart 1

Chart 2

Chart 3

FALLING DOLLAR FAVORS FOREIGN MARKETS ... Money tends to move away from a country with a weaker currency toward countries with stronger currencies. That's been another side-effect of the major dollar downtrend. Chart 3 plots the Dow Jones World Stock Average. What's of particular importance is the relative strength line along the bottom of the charts which compares the World Index to the S&P 500. The World/US ratio line turned up at the start of 2002 just as the dollar was peaking (see blue arrow). The vertical blue lines are meant to show the correlation between the start of the dollar decline and the beginning of the period of outperformance by foreign markets. Since the U.S. is included in the World Index, the relative strength has to be coming from foreign markets.

FOREIGN STOCK INDEX NEARS RECORD HIGH ... An even better example of foreign outperformance is seen in the EAFE Index iShares. That Exchange Traded Fund (ETF) is based on the MSCI Europe Australia and Far East Index (EAFE). The chart shows the EAFE challenging its early 2004 peak. None of the major U.S. stock indices are anywhere near their 2004 high. Even more impressive is the EAFA/S&P 500 ratio line which turned up during May and hit a new high today. A large part of the EAFE strength is coming from Australia and Asian countries that are producers of natural resources. And that doesn't even include commodity exporters like Canada and Latin America which have been leading the global rally. Foreign markets are getting a double benefit from the falling dollar. First, it's driving money into foreign markets. Second, by pushing commodity prices higher, the weak dollar is benefiting countries that produce commodities even more. And there are no signs of any these trends changing.

Chart 4

EXPECT SHORT-TERM PULLBACK ... The market ended the week on the downside. That's not too surprising and doesn't change the longer term picture. Chart 5 shows the S&P 500 SPDRs backing off from chart resistance at the June high. In addition, the 9-day RSI line is backing off from overbought territory at 70. That combination has led to some short-term profit-taking. The fact that Friday's weakness came on heavier volume is also a short-term negative. I think there's a strong chance that the pullback will drop to the late September low where I think it will most likely be contained. That would also represent a 50% retracement of the August/October rally. Rising oil prices continue to weigh on the stock market. Even so, I remain reasonably optimistic about a fourth quarter rally after the short-term pullback has been completed. I'll feel better as we move from October into November which usually starts the strongest three months of the calendar year. In the meantime, money is being made in commodity-related stocks and countries that produce those commodities.

Chart 5