FALLING DOLLAR FAVORS FOREIGN SHARES -- IT ALSO FAVORS FOREIGN ETFS OVER UNDERLYING STOCKS -- NEXT UPSIDE TARGET FOR S&P 500 IS 1120 -- NATURAL GAS IS FIDELITY'S TOP SECTOR FUND FOR THE WEEK -- GOLD NEARS TESTS OF MARCH 2008 INTRA-DAY AT $1033

FALLING DOLLAR FAVORS FOREIGN STOCKS... Arthur Hill reviewed some standard intermarket relationships on Thursday. One of the best known is the inverse relationship between the U.S. Dollar and commodity prices. That's why a falling dollar has had a bullish impact on commodity prices since the spring. The falling dollar has also boosted global stocks as money moved out of that safe-haven currency into riskier assets like stocks. But not all stocks rise equally at such times. A falling dollar has a much more bullish impact on foreign stocks. Since the March top in the dollar, for example, the S&P 500 has risen 56%. Foreign stocks, however, gained 72%. The stronger foreign performance was due largely to the falling dollar. The red line in Chart 1 is a ratio of the Morgan Stanley World Index (Ex USA) and the S&P 500. The green line is the U.S. Dollar Index. The inverse relationship between the two lines is very clear. Foreign stocks did much better than the U.S. from 2002 to the end of 2007 while the dollar was falling. Foreign stocks did much worse than the U.S. during the second half of 2008 as the dollar rallied. The dollar peaked in March of this year and has been falling since then. The rising ratio shows foreign stocks outpacing the U.S. since the dollar top in March. A weaker dollar favors heavier exposure in foreign stocks. The direction of the dollar also determines when it's better to use foreign ETFs.

Chart 1

STRONG CANADIAN DOLLAR BOOSTS EWC... The falling dollar does more than just favor foreign stocks. It also favors foreign ETFs over their underlying shares. The reason is that foreign stocks are quoted in their local currencies. Foreign ETFs are traded in the U.S. and are quoted in dollars. As a result, a weaker dollar causes the value of foreign ETFs to rise faster than their actual stocks. The red line in Chart 2 is a ratio of Canadian iShares (EWC) divided by the Toronto Index (TSE). The green line is the Canadian Dollar. The two lines trend together. When the Canadian dollar is weak (U.S. Dollar strong), the EWC underforms the TSE. Since March, however, the rising Canadian Dollar (weaker U.S. Dollar) has caused the EWC to rise much faster than the TSE. Since March 9, the EWC has gained 85% versus 52% for the TSE. A weaker greenback favors foreign ETFs.

Chart 2

1120 TARGET FOR S&P 500... With the S&P 500 now trading at the highest level in eleven months (and having exceeded its November high at 1000), we need to look for the next potential upside target. Based on the chart below, that would be around the 1120 level which is about 50 points (or 5%) above the current price. There are two reasons why 1120 comes into play. The first is the red resistance line drawn over the 2007/2008 peaks. The horizontal lines also show 1120 to be a fifty percent retracement of the entire bear market. Earlier in the spring, I wrote that a minimum upside target would be a 38% retracement (near 1000) which was achieved during July. With that first objective having been exceeded, the 50% retracement becomes the next potential target.

Chart 3

NATURAL GAS IS FIDELITY'S TOP SECTOR FUND FOR THE WEEK ... My Tuesday message wrote about natural gas and natural gas stocks presenting value in the energy group. I showed a number of individual gas stocks that had achieved (or were about to achieve) bullish breakouts. Unfortunately, there's no ETF that deals exclusively in gas stocks. However, there is a gas mutual fund. In fact, the Fidelity Select Natural Gas Fund (FSNGX) was the top Fidelity sector gainer for the week. Chart 4 (plotted through Thursday) shows the fund rising to the highest level in nearly a year. Its moving average lines are in bullish alignment. Its relative strength line (bottom of chart) has risen as well.

Chart 4

GOLD CHALLENGES RECORD HIGH ... Thursday's gold close at $1017 was a new record. Chartists, however, would prefer to see it exceed its March 17, 2008 intra-day high at $1033. I think it's just a matter of time before that happens. The inverse head and shoulders (or cup and handle) bottom in Chart 5 shows a range from $1000 to $700. That yields a potential upside target to $1300. The triangle to the right side of the chart yields a closer target to $1120. Chart 6 shows a point & figure chart of gold. It shows an intial buy signal at $960 during August and another at $965 earlier this month. Gold would have to close at $980 or lower to trigger a short-term sell signal.

Chart 5

Chart 6