Why the US Dollar is Key

By: Toby Connor | Tue, Aug 24, 2010
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Stocks:

The move to a lower low on Friday puts the odds squarely in the "one more leg down" camp. I've noticed a couple of patterns emerging in the stock market. The first one is the tendency for a market cycle to bottom on an anticipated news event. The last two intermediate cycle lows bottomed on or one day prior to a jobs report.

S&P Large Cap Index

The second is the tendency for a cycle to bottom only after a fake out earlier in the cycle.

S&P 500 Large Cap Index

I've been expecting a short daily cycle to balance out the extremely long cycle into the May flash crash (62 days trough to trough). But it doesn't look like we are going to get one. Every cycle has either run late into the timing band or stretched long. So from here on out I won't be looking for any more short cycles (which probably guarantees the next one will be).

So if we factor in the fake out principle and news driven bottom theory we are probably looking at the current daily cycle bottoming this week, possibly Friday (day 40) on the GDP revision. Lately the daily cycles have tended to run between 35 and 45 days with 39 or 40 being the norm.

News Event Driven Bottom Next Friday

I think we all realize the revision is going to be bad and common sense would suggest the market should go down. However the market is already in the process of discounting a bad number and has been for almost two weeks now. I suspect this is going to be one of those sell the rumor buy the news type events. And I expect it is going to catch the bears leaning heavily in the wrong direction expecting the market to act rationally and continue down.

When the market starts to rally out of that cycle bottom we could see a pretty aggressive move as shorts panic and have to cover. I actually expect this will quickly drive the market above the 1130 resistance level. Then it will just be a question of when sentiment reaches bullish extremes as to whether the market can test the April highs. If we start to see large negative money flows (a sign institutional traders are exiting) prior to bettering the April high then there is a good chance the cyclical bear is on its last legs.


Dollar:

I'm going to spend a good bit of time today on the dollar because it is going to be the key to what I envision unfolding over the next few months.

I'm going to start off with the largest 3 year cycle and then work backwards.

US Dollar Index

The last four major 3 year cycles have all run 3 to 3 1/2 years in length. The current cycle is 2 years and 6 months old. Now there is a chance the 3 year cycle could bottom this fall as the current intermediate cycle bottoms. However that cycle is due to bottom in November or early December. That would leave the 3 year cycle a bit short. For that reason I expect the current cycle to run at least one more intermediate cycle into the March - June time frame. This is a big reason why I think the C-wave in gold may have two additional legs up instead of just one.

Next, let's back down to the next smaller cycle - the yearly cycle.

Intermediate Cycle Low Prediction

I've marked the last two yearly cycles in blue (notice how they are making lower lows). The last two yearly cycle lows occurred in December. The current intermediate dollar cycle should bottom in late November or early December. That skews the odds heavily in favor of the next intermediate cycle low not only marking an intermediate bottom but also forming a higher degree yearly cycle bottom in the same 'end of the year' time frame as the last two yearly cycles.

After the aggressive collapse we've seen in the dollar over the last couple of months, there seems to be little question the dollar has begun working its way down into that yearly cycle low. The only question now is how long before the current intermediate cycle (which began on August 8th) tops. I suspect it will be fairly quickly. As a matter of fact I think the current daily cycle will most likely be the last right translated daily cycle imbedded within the current intermediate cycle.

US Dollar Index Prediction

Once this daily cycle tops, which I expect it to do next week or early the week after, there is a very good chance that will also mark the top of this intermediate cycle. As I've illustrated on the chart, I then expect every daily cycle after that to be left translated (tops in less than 10 days), and each to move below the prior cycle low (failed cycle) until the dollar puts in the yearly cycle low later this winter.

It's been my contention for some time that the only way stocks can rally is if the Fed continues to debase the currency. Remember, this is an election year so I think we can pretty much bank on the dollar moving down into the yearly cycle low right on schedule, possibly with extreme prejudice as Ben desperately tries to keep asset prices inflated into the elections.

But as I've been saying for a long time it simply isn't possible to print prosperity. I'll tell you what else is impossible to control - where the liquidity lands.

Ben would love for all that free money to create jobs, but as we know that just ain't gonna happen. The next best thing would be for all that liquidity to levitate the stock market. And I think it will to some extent, but there are already problems starting to surface with this plan. Not surprisingly they are the same problems that popped up in `08 as Ben tried to stop the real estate bubble and credit markets from collapsing. I'm sure you've noticed the problem by now. That's right; liquidity is leaking out of the stock market and flowing into the commodity markets.

US Dollar debasement

It's readily apparent in the above chart that stocks are already struggling as more and more liquidity leaks into commodities. The CRB however is having no trouble what-so-ever responding to the Fed's printing press. It is rising in lock step with the declining dollar. The fact that the fundamentals are impaired in most commodities just goes to show how much liquidity the Fed is actually dumping on the world.

I expect this pattern to continue and accelerate as the dollar moves into the yearly cycle low. I have no doubt we will continue to see a weaker and weaker response from the stock market leading to more and more panic printing by the Fed causing commodities prices to rise and rise.

Commodities are already trying to tell Ben to shut down the presses. As this continues they will soon be screaming for the Fed to shut off the money spigot. I really don't expect Ben to hear though. He was deaf to what his monetary policy caused in `08 ($147 oil and the collapse of the economy) and I expect he will not heed the warning signs this time either. This, of course, just means he will get the same result as last time. Eventually his monetary policy will spike commodity prices, especially oil and probably food, through the roof which will destroy the economy all over again.


Gold:

I've been looking for a swing high to possibly mark the top of the current daily cycle. Gold formed a swing on Friday that I think probably marked a short term top. If gold is now on its way down into the daily cycle low then I tend to think it will probably bottom along with the stock market sometime this week or early the following week.

US Dollar Index

My best guess as to how far the correction drops would be at least 50% of the recent rally. Most daily cycles do tend to give back at least 50%.

Gold Continuous Contract

A 50% retracement would take gold slightly below $1200. If you remember I was expecting smart money to push gold below the May pivot as the intermediate cycle bottomed last month. I explained at the time how big players routinely run stops to trigger heavy volume sell offs that allow them to take large positions into a very liquid environment. With the benefit of hindsight we know this is exactly what happened.

Now I don't think gold will be dropping anywhere close to $1155 during this correction, but I do think there are probably plenty of stops to be run below the psychological $1200 level. So I think we can probably look for gold drop below that briefly as smart money again runs the stops in order to panic retail traders into puking up their shares. My suggestion would be for anyone looking to enter or add to positions to do so as gold breaks through $1200.

Let me remind everyone that gold is the single strongest trending market on the board today. It is the only asset still in a secular bull market with unimpaired fundamentals. The dollar is the key here also. Every C-wave advance so far has been driven by a major leg down in the dollar and I don't think this one will be any different. I expect the final two legs up in this C-wave will be driven by the dollar falling into the yearly cycle low later this year and the 3 year cycle low next spring.

I did my best last month to convince traders and investors to buy the intermediate cycle low. I suspect many were unable to do so. Those intermediate cycle lows are the single best buying opportunities one gets in bull markets and they only come around once every 5-6 months.

The approaching smaller daily cycle low will be the next best opportunity to get long or add to positions in the one remaining secular bull market. If you missed the last cycle bottom in July I suggest you not make the same mistake twice.

 


 

Toby Connor

Author: Toby Connor

Toby Connor
Gold Scents

Gold Scents is a financial blog focused on the analysis of the stock market and the secular gold bull market. Subscriptions to the premium service include a daily and weekend market update emailed to subscribers. If you would like to be added to the email list that receives notice of new posts to Gold Scents, or have questions, email Toby.

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Source: The Contrarian Take http://blogs.forbes.com/michaelpollaro/
austrian-money-supply/