DOLLAR BREAKOUT RESULTS FROM HIGHER INTEREST RATES, BUT PUTS DOWNSIDE PRESSURE ON COMMODITIES
DOLLAR INDEX BREAKS SUMMER HIGH ... The U.S. Dollar broke through its summer high today and closed above 91 for the first time in eighteen months. The daily bars in Chart 1 show the short-term bullish breakout. The weekly bars in Chart 2 show that the USD is trading at the highest level since the spring of 2004. Chart 2 also shows that the next upside target for the USD is the April 2004 high at 92.29. Although the dollar has been rallying against the yen for weeks, today's upside breakout came mainly at the expense of the Euro. The bullish breakout in the dollar is tied to trends in other markets like interest rates and commodities. The main driving force behind the dollar rally is rising U.S. interest rates. The stronger dollar is having a depressing effect on commodity markets.
Chart 1
Chart 2
RISING US RATES ARE BULLISH FOR THE DOLLAR ... The main factor driving the U.S. Dollar higher is rising U.S. interest rates. The widening spread between higher U.S. rates and flat foreign rates is the main bullish factor. [One exception is Canada which has been raising rates. As a result, the Canadian Dollar remains relatively strong]. Chart 2 compares the 10-year T-note yield (green line) to the Dollar Index over the last eight years. The chart shows that interest rates lead the dollar. The sharp drop in rates during 2000 (resulting from deflation pressures) caused a major dollar peak two years later. The 2003 bottom in rates preceded the dollar bottom at the start of 2005. While short-term rates have been rising steadily since the middle of 2004, long-term rates have only recently started to climb (mainly due to heightened inflation pressures). The 10-year yield closed today at the highest level in a year. That puts it dangerously close to a challenge of its mid-2004 high. I suspect it's the recent surge in long-term rates more than anything else that's causing the bullish sentiment in the dollar. That's causing some selling in commodities.
Chart 3
DOLLAR VERSUS COMMODITIES ... The U.S. Dollar usually trends in the opposite direction of commodities. That inverse relationship can be seen clearly in Chart 4. The dollar peak at the start of 2002 coincided with a major upturn in the CRB Index. Although the inverse link between the two markets hasn't been as evident during 2005 as both have risen, Chart 5 shows that the dollar has had an impact on commodities since mid-year. The dollar drop from the start of July through the end of August coincided with a commodity rally. The early September bottom in the dollar coincided with a top in the CRB Index (and the oil market). The last week's upturn in the dollar has coincided with commodity selling. New dollar buying has also contributed to the recent selling in gold and gold shares.
Chart 4
Chart 5
GOLD ETF BREAKS 50-DAY LINE ... Along with most other commodities, the price of gold has also started to slip. I don't think it's a coincidence that today's bullish breakout in the dollar pushed the Gold ETF (GLD) beneath its 50-day average for the first time in months. Major support, however, is still likely in the $445-$450 region. Gold shares have also softened of late. Chart 7 shows the XAU Index threatening its 50-day line. Its relative strength ratio has softened over the last month. Part of the gold selling has to do with the start of the fourth quarter stock market rally. Added to that, today's dollar breakout may cause more short-term pressure on gold stocks. In my view, however, the longer-term outlook for gold and gold stocks remains bullish. For the time being, however, the pendulum has swung away from gold and back toward stocks.
Chart 6
Chart 7
S&P TREND IMPROVES -- SOX REGAINS 200-DAY LINE... The weekly bars in Chart 8 show the improvement in the S&P 500 this past week. Not only did it close back over its (red) 40-week average, but it closed above its (blue) 10-week average as well. Even more impressive was the heavy upside volume. That strong action moved the market out of its danger zone. Having survived the dangerous month of October, the market has now entered a seasonally strong period between now and yearend. The weekly histogram bars are still negative (below the zero line). However, they have risen for two consecutive weeks (meaning the MACD lines are starting to converge). While that doesn't constitute a "major" buy signal, it does suggest the covering of short positions (or lightening up on bear funds). With oil still on the defensive, fourth quarter market leadership is coming from financials, retailers, the transports, and technology. Most of the recent technology leadership came from Internet stocks which closed at a new recovery high (Chart 9), while semiconductors have been one of the market's weakest groups. This week, however, the SOX Index climbed back over its 200-day moving average (Chart 10). It's a good sign when even the weakest groups start to show some improvement.
Chart 8
Chart 9
Chart 10
