DOLLAR RALLY PUSHES GOLD LOWER AND MAY CAUSE CORRECTIONS IN COMMODITIES AND STOCKS -- MONEY MOVING OUT OF OVERBOUGHT DISCRETIONARY STOCKS IS MOVING INTO FINANCIALS AND HOMEBUILDERS
RISING DOLLAR THREATENS GOLD UPTREND... Tuesday's message wrote about an overbought condition in stocks and commodities, and showed gold in particular starting to roll over to the downside. Although some have questioned the viability of the dollar/commodity link, my view is that it's alive and well. Intermarket relationships aren't perfect and do get out of line on occasion. My experience, however, it that sooner or later they snap back into place. This may one of those times. Chart 1 shows the PS Dollar Bullish ETF (UUP) bouncing sharply this week (after bottoming in November). Gold is the market most sensitive to dollar moves. And, not surprisingly, gold is the market being most negatively impacted. Chart 2 shows the Gold Trust Shares (GLD) slipping below its 50-day average for the first time since August. The price pattern has the look of a "triple top" formation (marked by three peaks). Notice that the first peak took place in early November when the dollar bottomed. Notice also that the daily RSI (top of chart) and MACD lines (bottom) have been descending since October. That shows loss of upside momentum. Chart 1 also shows that the UUP is still well below its 200-day moving average. A move up to retest that major resistance line (or its late November peak) will help determine if this is just a bear market bounce in the greenback or something more lasting. That upside test may coincide with stocks and commodities testing some underlying support levels. At this point, however, I'm inclined to view all of these intermarket trends as retracements of current trends and not necessarily major reversals.
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Chart 1
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Chart 2
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Chart 3
GOLD IS STILL LINKED TO THE DOLLAR... Chart 3 shows the normally inverse relationship between the dollar (green line) and gold over the last three years. Although the relationship isn't perfect, it seems clear that dollar weakness starting at the end of 2008 has coincided with gold strength. The link was broken temporarily in the second quarter of 2010 when both rose together, but then snapped back into place during the second half. What's especially noteworthy about Chart 3 is that the UUP is bouncing off major chart support formed near the end of 2009 (see circles). That makes the current dollar rally more meaningful. And, in my view, will put downward pressure on gold (and most other commodities). Given the close correlation between stocks and commodities, a further dollar rally may cause some profit-taking in an overbought stock market as well. Chart 4 demonstrates those linkages. It shows the generally inverse relationship between the S&P 500 (red line) and commodities (brown line) versus the Dollar Index (green line). It also shows the close correlation between stocks and commodities. The implication is that further dollar strength should contribute to some profit-taking in overbought stocks and commodities.
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Chart 4
CONSUMER DISCRETIONARY STOCKS LOSE LEADERSHIP... Arthur Hill pointed out yesterday that some of the more economically-sensitive stock groups that had led the market rally for months were starting to slip in the relative strength rankings. Consumer discretionary stocks are one of those groups. Chart 5 shows the Consumer Discretionary SPDR (XLY) still in an uptrend. Its RSI line (top of chart), however, is starting to roll over from overbought territory at 70. More importantly, the XLY/SPX relative strength ratio (below chart) has been declining during the last month. Chart 6 puts the current uptrend in better perspective and also raises some concerns. The weekly bars in Chart 6 show the XLY right up against its early 2007 high near 38. The weekly RSI line (top of chart) also shows the XLY to be in overbougth territory (over 70) for the first time since April. The rising relative strength line (below chart) shows discretionary stocks leading the market higher since early 2009. Any hint of weakness in that leading group would be a further sign that the market may be entering a sideways consolidation or a normal downside correction. My best guess is that might entail a drop in the XLY to its 50-day moving average (see Chart 5) would would entail a correction of about 4%. That would probably coincide with a similar drop in the market as a whole.
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Chart 5
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Chart 6
SECTOR ROTATION FAVORS FINANCIALS ... Arthur Hill also pointed out that new signs of leadership were coming from former laggards like financials and homebuilders. I suspect that's the result of some sector rotation in progress. To demonstrate that point, Chart 7 plots relative strength lines of the Consumer Discretionary SPDR (blue line), Financials SPDR (red line), and homebuilders (green line) versus the S&P 500 (flat black line) since the spring. From April through November, discretionary stocks were leaders while financials and homebuilders were laggards. Since the start of December, the three groups have reversed roles. I suspect that some money rotating out of overbought market groups (like consumer discretionary and materials) is rotating into oversold groups like financials and homebuilders. That's not a bad thing for the market. In fact, new buying in financials and hombuilders is a good thing. The point of Chart 7 is to help explain why financials and homebuilders have been doing better of late. It also suggests some of the better places to be putting new stock market money in an overbought stock market.
Chart 7
VIX BOUNCES OFF CHART SUPPORT... It's been awhile since I've written about the CBOE Volatility (VIX) Index. The VIX (which normally trades in the opposite direciton of stocks) has been falling since last May and has helped support the stock market rally. Chart 8 shows their inverse relationship over the last year. The reason I'm writing about the VIX today is that it has reached potential chart support at last April's low near 15 (see circles) and is starting to bounce a bit. One of the basics of intermarket work is that chart action in one market often tells us something about another. The fact that the VIX is starting to bounce from important chart support is a warning that the S&P 500 uptrend may be in danger of a pullback. That's not necessarily a bad thing. I suggested on Tuesday that this didn't appear to be an opportune time to be committing new money to stocks or commodities. A decent pullback in both should provide better entry levels at lower levels.
