WEAK JOB REPORT WEAKENS DOLLAR AND BOOSTS BONDS AND GOLD -- XAU INDEX IS STALLED BELOW RECORD HIGH AND MAY BE HOLDING GOLD BACK -- FALLING DOLLAR MAY HELP EXPLAIN RECENT ROTATION INTO LARGE CAP STOCKS

SLOW JOB GROWTH BOOSTS BOND MARKET... Unemployment ticked higher during April and job growth was the slowest in two years. That hint at economic weakness pushed bond yields lower and bond prices higher (bond prices and yields always move in opposite directions). Chart 1 shows the 10-year T-note yield (TNX) falling today after a failed attempt to breach its 200-day moving average. Chart 2 shows the 7-10 Year Treasury Bond Fund (IEF) rallying today after bouncing off its 50-day moving average. The stock market is taking encouragement from falling yields and diminished risks for any additional Fed rate hikes. Prospects for lower U.S. rates, however, are weakening the dollar.

Chart 1

Chart 2

DOLLAR WEAKENS AS EURO TESTS OLD RECORD ... Lower U.S. rates, combined with the prospects for higher foreign rates, are keeping the U.S. Dollar in a downtrend. Chart 3 shows the U.S. Dollar Index trading lower today and nearing a test of its early 2005 lows near 80. A decisive close below that level would push the USD to a new record low. Meanwhile the Euro is moving in the opposite direction. Chart 4 shows the Euro in the process of challenging its all-time high against the dollar (just above 136) which was reached at the start of 2005. Needless to say, both currencies at or close to important chart points. We've pointed out before that foreign stocks usually benefit from the weaker dollar. So do U.S. multinationals that do a lot of foreign business (more on that later). That may explain the 2007 move into large cap stocks. One other market that stands to benefit from a weaker dollar is gold which is rallying today.

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GOLD NEARS $700 AGAIN ... Gold prices are bouncing another $7.00 today and are nearing a test of the 2007 highs just shy of $700. A decisive close through $700 would not only represent a bullish breakout, but would give bullion a psychological boost. [Gold often meets resistance around large round numbers]. Chart 5 also shows the Gold Trust Shares (GLD) bouncing off its 50-day average and a rising trendline. Chart 6 gives a longer view of gold's advance since last October. A continuing climb in gold depends heavily on continuing strength in the Euro and continuing weakness in the dollar. The same is true of gold stocks.

Chart 5

Chart 6

XAU INDEX IS TESTING ALL-TIME HIGH ... One of the most consistent of all intermarket relationship is the inverse relationship between gold assets and the U.S. Dollar. Nowhere is that more evident than in Chart 7. The green line plots the U.S. Dollar Index (which measures the dollar against six foreign currencies. The Euro has the biggest impact in the USD). The orange line is the Gold & Silver (XAU) Index of precious metal stocks. It's clear that they trend in opposite directions. For example, the 1996-2000 dollar rally coincided with a major downturn in the XAU (see arrows). The fall in the dollar at the start of 2001 helped launch a major upturn in gold shares. The most important feature of the chart is that both markets are at key junctures. The green line shows the Dollar Index testing its all-time low along the 80 level. The orange line shows the XAU testing its all-time highs around 150 reached in 1987 and 1996. The fact that the XAU is stalled at long-term resistance may also explain why precious metal stocks have lagged behind the commodity over the last year. That may also explain why the bull market in bullion has been stalled since last spring.

Chart 7

GOLD DOES BETTER WHEN XAU IS IN THE LEAD ... One of truisms of gold is that the commodity usually does better when it's being led higher by mining stocks. Chart 8 shows how that works. The black line is a ratio of the XAU divided by bullion. The XAU/gold ratio bottomed in late 2000 after falling for several years (first up arrow). That stronger performance by gold shares marked the start of a five-year bull market in the commodity. Prior to 2006, there were two serious declines in the ratio which slowed the gold advance. The two upturns in XAU/gold ratio in early 2003 and mid-2005 helped launch strong gold rallies (see up arrows). The last ratio decline started in early 2006 (down arrow). Gold has consolidated since then. The record shows that stronger mining stocks benefit the commodity. That's why an upside breakout in mining stocks would be a big help in resuming the bull market in bullion. For that to happen, however, the dollar is going to have to keep falling.

Chart 8

ANOTHER TELECOM BREAKOUT ... We've been showing upside breakouts in several telecom stocks include Verizon and Qwest Communications. Here's another one. The daily bars in Chart 9 show Centurytel (CTL) surging to a new 52-week high on Thursday on huge volume. Its relative strength (RS) line did the same (top of chart). It gets even better. The monthly bars in Chart 10 show CTL having achieved a bullish breakout through its 1999 high. That puts the telecom leader at a new record. The relative strength ratio at the top of Chart 10 also has a bullish look. The two converging trendlines on the ratio since 1999 have the look of an "ascending triangle". [That occurs when the upper line is flat and the lower line is rising]. An ascending triangle is a bullish pattern.

Chart 9

Chart 10

IS WEAK DOLLAR BOOSTING LARGE CAPS? ... We have to be careful about making generalizations without looking at the evidence. It makes financial sense that a falling dollar would benefit large cap multinational stocks more than smaller stocks (which do more domestic business). But that hasn't always happened. The red line in Chart 11 is a ratio of the Dow Industrials divided by the Russell 2000 Small Cap Index. The green line is the U.S. Dollar Index. From 2003 to to the end of 2004, the falling dollar didn't help large caps stocks. Since the start of 2005, however, the inverse link between the two lines has become more evident (see box). Let's take a closer look at those last two years.

Chart 11

MORE NORMAL RELATIONSHIP ... Chart 12 compares the large cap/small cap ratio (red line) to the dollar over the last two years. Their inverse relationship has taken on a more normal (or expected) trend. A rally in the dollar (green line) during 2005 coincided with large cap underperformance. Notice that the bottom in the Dow/RUT ratio last spring coincided with a big drop in the dollar. Over the last six months, each drop in the green line (dollar) has coincided with a bounce in the ratio. It may be stretch on my part, but it does seem that a weaker dollar since last spring may have something to do with the rotation away from smaller stocks to large Dow-type stocks with big multinational businesses.

Chart 12