New Dollar Trend Could Change the Markets

09/26/2011 10:22 am EST

Focus: FOREX

Thomas Aspray

, Professional Trader & Analyst

An important trend in the US dollar may be unfolding that would have long-lasting implications not just in the currency markets, but in stocks and precious metals like gold and silver as well.

The 14.7% drop in the shares of the SPDR Gold Trust (GLD) certainly got the market’s attention last week. It is the sharpest correction in some time, but veteran precious-metals investors are likely accustomed to the volatility. For example, in October 2008, GLD dropped by more than 28% in just three weeks, falling from a high of $99 to a low of $66.

Gold is lower again in early-Monday trading, and the CME margin hike that will take effect after Monday’s close is adding further downward pressure to both gold and silver prices.

Since the beginning of August, there have been some interesting changes in the relationship between the US dollar to gold and the S&P 500, which could have longer-term significance.

While many politicians have been complaining about the weak dollar for many years, it certainly has given exports a boost. This was one of the only bright spots for the economy during the financial crisis, because without the strong exports, things would have been even worse.

If the dollar has made as significant turn, which is likely from the technical evidence, it could be a stronger dollar that helps fuel a new uptrend in the US stock market. In light of the global turmoil and despite all the problems in the US, the dollar is starting to look much more attractive.

chart
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Chart Analysis: This percentage-change chart tracks the percentage performance of the Spyder Trust (SPY), Powershares DB US Dollar Index Bullish Fund (UUP), and the SPDR Gold Trust (GLD) since August 2011.

  • The sharp drop in GLD is the most evident, as it was up over 17% in August but is now up just 1.3%
  • We can see that GLD has given up about half of its gains from the July lows
  • UUP, on the other hand, is up 5%, and it was hard to imagine that it would be the best place to be back in early August when the debt-ceiling debacle was occurring
  • SPY has had a rough time, as it is down 11.8% since the beginning of August
  • It is interesting to note that the performance lines for GLD and UUP did cross recently

NEXT: See Trend Unfolding on Dollar Index Chart

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chart
Click to Enlarge

The daily chart of the Powershares DB US Dollar Index Bullish Fund (UUP) shows the breakout from a short-term double-bottom formation (line b).

  • There is chart resistance at $22.50 with the 38.2% Fibonacci retracement resistance from the June 2010 highs at $22.75. The 50% resistance is at $23.37
  • The low volume at the retest of the lows in August and strong volume on the rally are consistent with a double-bottom formation
  • The daily on-balance volume (OBV) is positive and above its weighted moving average (WMA). The weekly OBV does show a long-term positive divergence and is close to an upside breakout
  • There is initial support now at $21.90 with the rising 20-day exponential moving average (EMA) at $21.65
  • Stronger support stands at the gap in the $21.42-$21.24 area

The SPDR Gold Trust (GLD) closed below the Starc- band last week after trading near the weekly Starc+ bands for most of the past two months.

  • The minor 50% retracement support level is at $156.82 with weekly chart support from the May 2011 highs in the $153.62 area
  • The minor 61.8% retracement support is at $149.98 with the weekly uptrend, line d, in the $147 area
  • Volume increased on the decline but was well below the levels seen in August
  • The weekly OBV formed a slight divergence at the highs and has now dropped back to the uptrend, line e
  • The daily OBV (not shown) formed a negative divergence at the recent highs and is well below its declining weighted moving average
  • The first band of resistance is in the $165.70-$170 area with much stronger resistance in the $173-$175 area

What It Means:The action in the US dollar is the most significant, and while there still needs to be further confirmation, if a major low is in place, it could be the start of a trend that will last several years.

I do not think that this is necessarily bearish for gold’s major trend, as the monthly OBV did confirm the August highs. A several-month corrective period in gold is the most likely scenario, but the strength of the first rally will be important.

As for the stock market, a rebound is likely over the near term, but it will take strong Advance/Decline (A/D) numbers to confirm that the worst of the selling is over.

How to Profit: As previously recommended in August, buyers should be long the Powershares DB US Dollar Index Bullish Fund (UUP) at $21.18 with a stop at $20.73.

As suggested last Friday, investors should have covered half of any hedges they had on long GLD positions. Though GLD could see another wave of selling before a strong rebound, do not panic out of long positions now. Those who wish to lighten up should get a better chance in the next week or two.

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