BIG DROP IN CHINESE SHARES CAUSES SELLING IN GLOBAL STOCKS AND COMMODITIES -- COPPER AND OIL (AND THEIR RELATED STOCKS) ARE HIT THE HARDEST -- SAFE HAVEN MONEY IS MOVING INTO THE YEN AND TREASURIES -- OVERBOUGHT STOCKS ARE STARTING TO SLIP

SHANGHAI INDEX HAS LOST 23% DURING AUGUST ... I had been surprised at how little attention was being paid to the big drop in Chinese shares since the start of August. That's why I warned on Friday that the big drop in Shanghai could cause profit-taking in global stock and commodity markets. Today's 6.7% drop in Shanghai has gotten everyone's attention. Chart 1 shows the SSEC tumbling to a new three-month low today. That puts it 23% below its August 4 drop. Chart 2 shows China iShares falling 2% and undercutting its 50-day average. Chart 3 shows Hong Kong iShares tumbing nearly 4% and also breaking their 50-day line. China-related stocks are leading today's global retreat. Not surprisingly, commodities are falling right along with stocks. Two of the biggest losers are copper and crude oil which have been directly tied to China. Treasury bonds are rising as stocks fall. Safe haven money is also flowing into the Japanese yen. The fact that we're entering the seasonally dangerous month of September may also be prompting some profit-taking in global stocks.

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COMMODITY CORRECTION DEEPENS ... I've written previously about possible "double tops" showing up in commodity markets. Today's selling is reinforcing that view. The CRB Index is falling more than five points today with biggest losses in copper and energy. Chart 4 shows the DB Commodities Tracking Index Fund (DBC) touching a new August low after a failed test of its June high. Chart 4 shows the United States Oil Fund (USO) falling more than 4% after failing a retest of its June high near 40 (as crude oil has fallen below $70). Chart 6 shows the Copper ETN (black line) falling nearly 5% after doubling in price since December. Copper has also been strongly linked to China since the start of the year. It's no surprise to see China's drop starting to pull copper lower as well. I also pointed out last week that global stocks and commodities were highly correlated which meant a correction in one implied a correction in the other.

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YEN TURNS HIGHER ... The Japanese yen has become one of the world's strongest currencies during August. That's usually a sign that global traders are turning more defensive. Chart 7 shows Japanese CurrencyShares (FXY) hitting a two-month high against the U.S. Dollar. Chart 8 shows some profit-taking in the Canadian Dollar. That makes some sense since the Canadian currency is usually tied to the trend of commodities.

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SHAKY RALLY IN S&P 500 AND QQQQ WEAKENS ... I wrote last week that the August rally in the stock market was on shaky technical ground. Two of the reasons were the lack of upside confirmation in the 14-day RSI line and daily MACD lines. Charts 9 and 10 show the "negative divergences" in both markets. I also wrote recently that major resistance in the QQQQ resided near 40. Chart 11 shows the QQQQ backing off from a major resistance line drawn over its 2007/2008 highs and chart resistance along its early 2008 low (see arrow). That's a logical spot to expect some profit-taking in the QQQQ and the rest of the market. Initial downside support in any market pullback resides at their mid-August lows. Any break of those lows would signal a deeper autumn correction.

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WATCHING THE VIX ... The CBOE Volatility (VIX) Index has been trading sideways near chart support in the low 20s. It's up more than 7% today as stocks drop. To signal an upturn, however, the VIX needs to close above its mid-August intra-day peak at 28.39. An upside breakout in the VIX would most likely coincide with a downturn in stocks. The VIX has a seasonal tendency to bottom in July and peak in October. A higher VIX would fit the normal pattern for weaker stocks during the autumn months.

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TREASURIES CONTINUE TO RALLY ... One of the early signs of an impending stock market correction is money flowing back into Treasuries. On Friday, I showed bottoming signs in the the 7-10 Year Treasury Bond Fund (IEF). Chart 13 shows the IEF hitting a two-month high and moving closer to its July peak. Chart 14 shows the 20+Year T-Bond Fund (TLT) already testing that level. Rising Treasury prices are normally a sign that investors are turning more defensive on stocks. Falling commodity prices are also supportive to bonds.

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