Bearish Two Bar Reversal Threatens The Pre-Christmas Rally

• Two bar reversal brings the effect of the rate hike back to reality
• Broadly based dollar ETF breaks to new highs
• Gold closes at a new low on expanding volume

Earlier in the week I pointed out that many of the market averages had formed exhaustion days on Monday and that these formations typically have a bullish effect for between 5-10 sessions. This, as we can see from Chart 1, happened to be the fourth in a series of minor reversal formations that had developed since October. Bearing in mind that several shorter term momentum indicators were deeply oversold, my conclusion was that the combination of the exhaustion day and some oversold very-near-term oscillators could well support a modest year-end rally. Thursday’s action has muddied the picture on that conclusion. First, the bullish effect of Monday’s pattern only lasted for two days and that suggests a weaker technical structure than appeared apparent earlier in the week.

Chart 1

Second, today’s abrupt reversal of Wednesday’s strong trading session (see Chart 2) has now turned out to be the second bar of a bearish two-bar reversal, which means that we should now expect to see some weakness. Only a rally above the Wednesday or Thursday highs would cancel out this bearish omen.

Chart 2

Candlestick watchers will note that the Wednesday/Thursday combo resulted in the formation of a bearish engulfing pattern. Seeing how volume on the NYSE was higher for the (black) engulfment day, no matter how you slice it, the post-Fed interest rate hike market characteristics have been bearish.

Chart 3

It’s true that some of these shorter-term oscillators remain oversold, as shown in Chart 4.

Chart 4

However, a more powerful influence is being felt from the less sensitive oscillators, such as the KST and the NYSE Cumulative net new high indicator, both of which are featured in Chart 5. Note that the KST for the SPY in Chart 2 is also still bearish.

Chart 5

US Dollar

The euro contains an approximate weighting of 56% in the US Dollar Index, which to some extent, makes the Index an inverse version of the euro. The Wisdom Tree Bloomberg US Dollar Bullish Fund, the USDU (Chart 6) is a far more broadly based entity. That means that its Thursday upside breakout all the more impressive. At present this action is not being supported by the KST, but you can see the MACD, which is a little more sensitive than the KST, has started to turn up. That could well enable a KST reversal as well.

Chart 6

Chart 7 shows that the Dollar Index itself is in a similar condition relative concerning the KST and MACD. Even though it has been lagging on a price basis by failing to register a new high, it has nevertheless managed to move back above the green breakout trendline, and that action alone suggests higher prices.

Chart 7

Another reason for expecting the Index to advance lies in the fact that the dollar is largely driven by its safe haven status or lack thereof. This is illustrated in Chart 8 by comparing the Index, to the ratio between the Barclays 7-10-year Trust, the IEF to the iBoxx High Yield ETF, the HYG. Note that the ratio has been plotted in the chart to correspond with price movements in the Dollar Index itself. In effect, when bond investors are losing confidence, they bid up the IEF (quality) relative to the HYG (riskier high yield). Earlier this week the ratio touched a new high and that suggests that the Index will as well.

Chart 8

Gold

When the dollar rallies it usually provides a headwind for gold. Chart 9 shows that the current situation is no different this time around, as the gold price closed at a new low on Thursday. Unfortunately, this is happening as the volume is expanding on the GLD. Note that the percentage volume oscillator (PVO) in the bottom panel is not that far from a selling climax level, so the downside may be limited. At this point, caution is definitely the order of the day.

Chart 9

The same is true for the gold miners, even though the Market Vectors Gold Share ETF (GDX) remains above its “lucky” $13 support trendline. Volume has been expanding on the downside recently and the PVO has just broken a down trendline. This suggests that activity will continue to grow which, given the weakness in the metal itself, hints that the expanding volume will take place on the downside. As long as $13 continues to hold all is relatively well. However, if it breaks, the price will have completed a bearish consolidation head and shoulders. That means that if our expectation of higher volume proves to be correct it could be a deadly combination for gold shares.

Chart 10

Good luck and good charting,
Martin J. Pring

The views expressed in this article are those of the author and do not necessarily reflect the position or opinion of Pring Turner Capital Group or its affiliates.