Thursday, February 10, 2011

Major dollar rally setting up

The Dollar has had a nice move up from November 2010 when all the media was talking about was hyperinflation. Well, it seems that psychology has not changed. People are still ultra-bullish on stocks at their highest levels since June of 2008, commodities at their highest levels since the beginning of October 2008, while  calling death to the U.S. Dollar and bonds. It is in this type of extreme sentiment environment that markets reverse. The Dollar may need a little more downside to wash out the few bulls that remain in that market, but I suspect the Dollar is set to commence on a major rally. This would be supportive of a decline in all of these liquidity driven markets for at least a period of time, and possibly something more serious. Also of note, Emerging Market fund outflows are at their highest levels since 2008. Before the crash of 2008, emerging markets topped a few months after U.S. stocks did. It is possible, under the bearish scenario I laid out in my last post, "Market Update", that this time emerging markets are leading the way down. Under the bullish scenario, this would just be a 15-20% correction in Emerging markets. Nevertheless, all of these markets are being driven by liquidity right now, in what Elliott Wave International calls "All the Same Market". When liquidity is expanding, stocks, commodities and other inflationary assets are pushed up, and when liquidity contracts, markets all go down together, as we saw in the second half of 2008. I strongly maintain that the bear market is NOT over, and probably has about 6 years to go. Again, the action over the next few months should provide clarification as to whether this bear market rally is going to continue for a while, or whether it is ending now. We'll let the market decide that. Below is a longer term analysis of the U.S. Dollar. the same dynamics of liquidity apply to the U.S. Dollar, except in reverse. As liquidity expands, people become more optimistic and selling dollars to buy inflationary assets, and as liquidity contracts, people become more fearful and liquidate inflationary assets to raise cash.

Longer term, the U.S. Dollar is forming a large triangle on a weekly chart. Triangles are consolidation patterns, and in this case I believe a basing pattern for a new Bull Market in the U.S. Dollar. This next uptrend in the U.S. Dollar will be key. If the uptrend breaks strongly through the upper trend line, it would suggest the Dollar has been basing since March 2008 and has already started its Bull Market. If the uptrend is corrective and weak, that would suggest the Dollar will make one more minor new low below its March 2008 low of 70.70. In my last post, regarding the stock market, I also mentioned that this next downtrend in the stock market will be key as well. The nature and extent of the next rally in the Dollar and bonds and decline in the stock market (which should all occur simultaneously) should provide clarification to the next major move for stocks commodities and other inflation assets. My expectation of a coming significant intermediate term dollar rally  is consistent with my expectation with AT LEAST a correction in all of these liquidity driven markets.