Based on a better than expected US jobs report on Friday, the dollar and stock market rocketed higher.
That’s interesting, because “the market” has anticipated the FOMC will lower US rates in their upcoming meeting in late July – perhaps by 50 basis points.
However, based on the gathering strength in the US Dollar Index (USDI), the FX market is indicating the possibility of no rate cut at all.
As you can see, USDI bounced significantly to stay above its long-term uptrend line.
And while there are key reversals at the top of the current range, the dollar remains in that uptrend. Therefore a breakout to the upside is more likely than the downside at this time.
Is that the action of a currency expecting a rate cut? It doesn’t seem that way.
Meanwhile, the prevailing bearish price action in EURUSD, GBPUSD and AUDUSD suggests weakness in these pairs is likely to continue.
Let’s look at EURUSD (the Euro against the dollar) first …
The long-term downtrend from 1.36 to 1.12 doesn’t appear to be over yet, although it has stalled for the last several months.
The bearish head and shoulders pattern is still intact, and the price has failed to rise above the neckline of that pattern. Now we’re near the last line of support at 1.11.
Once that breaks then look out below! I expect parity with the dollar would be the next target.
The GBPUSD (British pound against the dollar) pair is a lot like the EURUSD chart but even weaker. There’s been a long-term downtrend from 1.75 down to 1.25:
Here we see a double top and a complex head and shoulders pattern with more than one shoulder on the right-hand side.
At the moment GBPUSD isn’t far away from its nearest support line. And once that line is broken – which I expect – the next stop would be 1.20 and then much lower after that.
Both these pairs are good potential shorts but be patient. There’s no need to rush into a trade just yet.
After all, they might behave like AUDUSD (the Australian dollar against the U.S. dollar) before a serious drop.
AUDUSD’s dead-cat bounce the last couple of weeks might look encouraging to bulls, but it appears to have petered out as I expected:
I predicted this bounce because we saw a bullish key reversal a couple of weeks ago at a major support level in this pair. I also thought it wouldn’t bounce any higher than the recent downtrend line.
So far both those predictions have proved to be correct. So what’s next?
There’s nothing in this chart to suggest a genuine turnaround and over time I expect this pair to join EURUSD and GBPUSD on a continuing long-term downtrend. Short any rallies in this pair and wait …
Now for a short position I’ve favored for some time (and still hold): USDJPY (the dollar against the Japanese yen).
This pair has found interim support at 107 and while it’s possible the recent rally will continue, I believe any price rise will inevitably flame out. That means USDJPY will resume traveling in its primary direction…lower.
As with AUDUSD, short any rallies and be patient.
So how about a lesser-known pair I brought to your attention not long ago?
AUDCAD (the Australian dollar against its Canadian counterpart) is sitting at a critical support area right now. However, all the signs are bearish:
The double top has been followed by steadily lower highs to form a descending triangle.
That’s why I firmly believe this pair is headed much lower. Consider selling it with a stop order at 0.9911 with your stop loss near parity. I would look at taking profits at the 0.97 area.
Patient traders should be well rewarded on this one and any AUDCAD bounce should be considered a short opportunity.
Now for the biggest question in my mind: where gold is headed now.
Let’s start with the gold/silver ratio (that’s the gold price divided by silver price). This ratio has behaved in extreme ways lately: it’s climbed up to levels last seen in 1991.
The current ratio is above 93, which is well above the 50-year average of 57, 25-year average of 64, 10-year average of 66 and also the 12-month average of 80.
When something that statistically unusual happens, it should get your attention.
After all, shouldn’t something this extreme revert to the mean?
The current outstanding bet is that silver price will grow quicker than the gold price or the gold price must fall quicker than the silver price. Conventional wisdom says investors could benefit from this situation by shorting gold and going long silver.
However, based on the current price action of XAGUSD (spot silver), and that of the gold/silver ratio, I’m hesitant to make these assumptions.
Because based on the silver chart below, it appears silver is poised to break to the downside, not the upside.
In this monthly chart, silver’s recent rise looks more like a dead-cat bounce than a bullish breakout of any kind.
You can see XAGUSD has formed a long-term descending triangle, then failed to break the downtrend line despite recent price action. Silver looks to be headed back to the lower support line at sub $14 price levels.
Now onto gold (XAUUSD) … a few weeks ago, I spotted the break-out at the $1351 level and bagged gains of over 900 pips in this pair.
But lately there’s been a retracement. Since soaring to a six-year high of $1,440 last week, XAUUSD has settled back to $1,398.
That doesn’t mean gold’s rally is over. It’s simply what I believe to be the early stages of consolidation. The longer gold can hold here, the more powerful the next phase of the rally.
Any gold price decline should be contained around the $1360 price level. So although it may take some time, gold should ultimately head higher.
The only thing holding me back from taking a long-term long position right now is the gold/silver ratio. After all, it’s at historic levels now.
But it certainly looks like these two metals are poised to completely decouple. While gold could be dragged down by silver prices in the short term, I see silver going lower, and gold contained in a trading range between $1,360 and $1,420.
Translation: this means the already-historically-high gold/silver ratio could keep going higher yet. Remember the markets can stay irrational longer than we can stay solvent!
There’s another factor to consider: the FOMC interest rate decision at the end of this month could potentially be very catalytic for gold prices and of course the U.S. dollar too.
The same could be said for the stock market.
While the Nasdaq and S&P500 stock indices soared to all-time highs, the DJ30 did not. That suggests the market is not as sound as appearances might suggest. All three indexes should be setting new highs together if the market is truly strong.
So while it appears the path of least resistance in stocks is still higher, I’m getting the feeling that chasing stocks at current levels could turn into a bull trap in the not too distant future.
Besides the divergence between the DJIA and the other two major indexes, there’s another reason to be cautious.
The difference in volatility in the last year and a half is markedly higher than the volatility during the more orderly runup in previous years.
Just look at the length of the bars in the above chart in recent times as compared to several years ago. Today’s bars are much longer (i.e. more volatility).
Normally you see higher volatility like this at major trend changes, so treat this volatility as a warning sign. I’m not about to stand in front of a potential stock market bull train with a short here, but I’m not ready to hop aboard as a bull either.
So let’s summarize this week: the dollar looks strong across the board. I still expect it to ultimately lose out to the even stronger JPY over time.
Silver looks bearish, and gold looks to consolidate its gains (for now). And stocks look bullish but not enough that I’m willing to go long on an index position.
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I wish you a very healthy and prosperous trading week.
Mark “USDBullRun” Shawzin