EURO/DOLLAR INDICES HIT FIB RETRACEMENTS -- GOLD NEARS TRENDLINE AS RSI HITS SUPPORT -- DISSECTING THE PERCENT PRICE OSCILLATOR -- OIL DIVERGES FROM STOCK MARKET -- SMALL BEARISH DIVERGENCE FORMS IN NYSE AD VOLUME LINE

EURO AND DOLLAR INDICES HITS FIBONACCI RETRACEMENTS ... Link for todays video. Some classic inter-market relationships were shaken, and perhaps stirred, over the last few weeks. First, both the Dollar and gold declined rather sharply the last three weeks. Second, weakness in the Dollar and strength in stocks did not help oil as crude fell sharply over the last two weeks. There is clearly some turmoil in the markets right now. Lets take a look at some key inter-market charts individually. First, chart 1 shows the US Dollar Index ($USD) breaking break channel resistance with a big surge above 79 in November. Broken resistance turned into support as the index consolidated into early January. With a decline 12 of the last 14 days, the index broke support and this channel breakout is now in question.

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Chart 1

The Dollar could garner some support near current levels from the 62% retracement and strength in 2-year Treasury Yields. The current decline retraced just over 62% of the November advance. This Fibonacci retracement is not a hard support level or a definitive reversal point, but it puts me on alert for a potential reversal in this area. A surge back above 79.25 would recapture the prior support break and call for a reassessment. I am also watching the 2-Year Treasury Yield because it peaked ahead of the Dollar in April and bottomed ahead of the Dollar in early November. While the Dollar deteriorated the last few weeks, this yield has held near the .60 area. A break above the January highs would call for higher yields and this would be Dollar positive. Chart 2 shows the Euro Index ($XEU) moving to resistance from broken support and the 62% retracement mark.

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Chart 2

GOLD NEARS LONG-TERM TRENDLINE AS RSI HITS SUPPORT ZONE... While the 2011 decline in gold has been quite sharp, I still consider it a correction within a bigger uptrend. Chart 3 shows weekly prices over the last 2 1/2 years. The Gold Continuous Futures ($GOLD) broke resistance in February 2009 and RSI surged above 60. Gold formed a succession of higher highs and higher lows as RSI held the 50-60 zone the next two years. There were at least four 5 to 10 week corrections along the way. Each formed a falling wedge of sorts and the advance continued with the wedge breakout. The current correction is four weeks old, but we have yet to see a falling wedge or bullish continuation pattern evolve (such as a falling flag). Nevertheless the first evidence of support is at hand as gold nears the trendline extending up from the April 2009 low. RSI is also moving into its support zone (40-50).

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Chart 3

Chart 4 shows daily prices with the Percent Price Oscillator (5,35,10) moving below 2% for the third time in 12 months. The prior dips below 2% suggested that gold was oversold and ripe for a reversal. Being ripe for and actually getting a reversal are two different things though. At the very least the Percent Price Oscillator (PPO) needs to move above its signal line to signal an upturn. It is also possible to draw trendlines based on the reaction highs and lows in the PPO. A signal line cross and trendline breakout would indicate a bullish reversal in momentum. Should this decline in gold continue, I am marking the next support zone around 1250-1260. This area stems from broken resistance and the 62% retracement mark.

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Chart 4

DISSECTING THE PERCENT PRICE OSCILLATOR... What exactly does the Percent Price Oscillator (PPO) measure? In a nutshell, it measures the percentage difference between two moving averages. Its cousin, MACD, measures the absolute difference between two moving averages. This makes MACD values dependant on the price of the security. Stocks with high prices, like Google (612), will have much higher MACD values than stocks with lower prices, like Intel (21). PPO takes MACD one step further by dividing the value by the longer moving average. This puts its in percentage terms and allows chartists to compare levels over an extended period of time or against another security.

Chart 5 shows the 5-day EMA for gold (green) and the 35-day EMA (red). The PPO (5,35,10) is shown in the indicator window. Notice how the PPO turns positive when the 5-day EMA moves above the 35-day EMA and negative when the 5-day EMA moves below the 35-day EMA. As an overbought or oversold indicator, one can look for instances when the 5-day EMA is relatively stretched. On the upside, the 5-day EMA appears relative stretched (overbought) when it is more than 4% above the 10-day EMA. On the downside, the 5-day EMA appears relatively stretched (oversold) when it is more than 2% below the 10-day EMA. Oversold is not outright bullish and overbought is not outright bearish. Overbought and oversold readings alert us that prices are getting overextended in one direction or another and risk of a reversal is increasing. Chartists need to use other analysis techniques to actually identify a reversal.

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Chart 5

OIL DIVERGES FROM STOCK MARKET WITH SHARP DECLINE... Chart 6 shows West Texas Intermediate ($WTIC) getting hit rather hard over the last two weeks with a decline from 92 to 86 (4.65%). This is the steepest 10 day decline since August. Despite a break below the mid-December low, I still think the overall trend is up for oil. $WTIC has a big support zone around 84-87 from broken resistance. I also applied Andrews Pitchfork to the May closing low, July closing high and August closing low. The lower line extension marks support around 86.

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Chart 6

Weakness in oil is a concern because it is diverging from the stock market. A look back at 2010 shows oil peaking ahead of the S&P 500 in April and bottoming before the index in May. Oil and stocks have been advancing together since late August. This sudden de-coupling when stocks are overbought is another warning sign.

SMALL BEARISH DIVERGENCE FORMS IN NYSE AD VOLUME LINE... The warning signs for stocks continue, but we have yet to see breakdowns or material selling pressure. There will be a correction or a pullback one day. After the fact, analyst will review the indicators to find those that foreshadowed the correction. Finding that indicator before the actual correction is the hard part. Heres an attempt. A small bearish divergence is taking shape between the NY Composite ($NYA) and the NYSE AD Volume Line. A bearish divergence forms when the index forges a higher high and the indicator fails to confirm with its own higher high. Such is the case with the NYSE AD Volume Line now. Despite this bearish divergence, the AD Volume Line remains in an uptrend overall. Support is well established with the January lows. A break below these lows would be a bearish development for the AD Volume Line and increase the chances of this much awaited stock market correction.

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Chart 7

The AD Volume Line is a running total of Net Advancing Volume (volume of advancing stocks less volume of declining stocks). You can read more about this indicator in our ChartSchool click here.