With European debt markets getting
little relief thus far from the Ireland bailout, we need to keep a continued
eye on the U.S. dollar (UUP).
A weaker U.S. dollar (UDN)
tends to provide tailwinds for stocks (DIA), commodities (DBC), gold (GLD),
and silver (SLV).
Therefore, a longer-than-expected rally in the greenback may provide
headwinds for these assets, with gold being the possible exception in the
near term. The dollar represents one way to monitor the health of the
"risk trade" in general.
We outlined some concerns relative to a
dollar rally and risk aversion on November 10th. With the Federal Reserve embarking on an aggressive
money printing campaign (a.k.a. quantitative easing or QE2), it seemed
unlikely the dollar would muster the strength for a 7% rally, but that is
exactly what has happened.
We will continue to have competing
forces in the currency markets in the form of debt problems in Europe vs. Fed
policy in the United States. Fundamental drivers related to a weaker dollar
and higher assets prices are outlined on this QE resources page. To find the competing bullish forces related to the
dollar, you need to look no further than Portugal, Spain, and Italy over the
next few months.
There are four relatively easy ways to
track the progress of the dollar/risk trade. The first is to monitor the
dollar’s behavior near its 200-day moving average (shown below).
The second way to monitor the health of
the dollar’s current rally is to evaluate the reaction of market
participants as the U.S. Dollar Index trades between 80.89 and 83.06. These
levels have coincided with significant trend reversals in the past (see
arrows below). If the buck’s rally is to be short lived, then the
horizontal blue band shown below is a logical area for the bears to regain
control.
The third way to keep an eye on the
buck is to watch the 10-week moving average (MA). Notice in the chart below
how significant rallies in the dollar were accompanied by a turn up in the
10-week MA (think blue line). The current turn would be more significant if
it remains in place at the end of the week.
The fourth method to take the
dollar’s temperature is to look for a zero cross of the Rate of
Change (ROC) indicator on a weekly chart. Past rallies of any significance
and duration have been accompanied by a bullish cross of the zero line in
ROC. A cross has not taken place yet, which means some continued skepticism
is warranted as to the sustainability of the dollar’s current rally.
For now, the bulls remain in control of
the dollar and the bears remain in control of the euro (FXE). In terms of equities (SPY),
Stock Market Levels to Watch remains relevant in the face of
continued weakness in risk assets.
Disclosure: Long UDN, DBC, GLD, SLV
Chris Ciovacco
Ciovacco Capital
Chris Ciovacco is the Chief Investment Officer for Ciovacco
Capital Management, LLC. More on the web at www.ciovaccocapital.com
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