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Dollar Diamond

April 28, 2003

Diamond patterns are often seen as reversal points on the charts, but sometimes they manifest as consolidations within a major trend. The following weekly chart shows what appears to be a diamond as a consolidation pattern - ie having broken DOWN from the diamond, the Dollar looks like it is on the point of softening quite strongly.

If the breaks down is confirmed, the implied measured move target from the following Point and Figure chart is 84, or some 14% below its previous low.

Of course, should this happen, then the price of all imported goods (except from those countries to which the USD is pegged - notably China - will rise by 14%)

Clearly, the most important commodity that is imported into the USA is "oil", and the following monthly chart of Brent Crude shows support at around $18 - $20 - around 20% - 25% below the current price.

So, from the perspective of those charged with the responsibility of "managing" the economy, a 14% fall in the US dollar is unlikely to cause major damage to the US economy arising from imports - given that most consumer imports and oil will either stay constant in price or fall in price.

On the other hand, a lower dollar will stimulate exports by making US products relatively less expensive to other importers and, provided the bond yields continue to fall (giving rise to offsetting capital gains to overseas holders) - a falling dollar is unlikely to give rise to a flight of capital.

Of course, falling yields will further stimulate the equity markets to the upside, as well as the property markets - and if all this can be engineered then we can all live happily ever after.

If the tax cuts and withdrawal of double taxation on dividends have their desired effect then this, coupled with all the above, should give further support to a rising equity market.

So what are the equity charts telling us?

First, the good news:

The On-Balance-Volume chart gave a buy signal when it rose to new heights relative to the most recent past:

Now the bad news:

The S&P is showing signs of tiring:

Note the bearish rising wedge patterns on both the price and OBV charts. Note also that the MACD is in historically overbought territory.

On the other hand, the Dow chart is showing a ray of light: The PMO oscillator is not yet in overbought territory and it could be argued that the price has been moving inside a bullish triangular pattern.

If the price breaks up out of the triangular pattern, three things will happen:

  • The price will also break up out above its 200 day MA
  • The Dow will confirm the upside breakout of the Transports and give a Dow Theory buy signal
  • The apparent rising wedge on the $SPX chart will not be confirmed.

So we are in a nail bighting time. Will the rising wedge on the $SPX break down - thereby probably causing the Dow triangle to abort on the downside and confirming a double top on the Dow?

Well, unfortunately the OBV of the Dow is showing some resistance and a possible triple top dating back to December.

What about the major components of the economy - retail, real estate and motor cars?

Walmart's chart is showing a rising wedge and an OBV chart that is battling to break up:

GM's chart is showing the same thing:

Fannie Mae's chart is seriously overbought, but its OBV has broken powerfully to the upside:

What about the beneficiaries of a lower USD, eg Microsoft and IBM?

Microsoft's chart is a bit stronger, with a triangular consolidation pattern that seems capable of breaking to the upside.

IBM's chart is also looking OK

Finally, lets have a look at interest rates.

$TYX is looking weakish, implying that long yields could remain soft (and capital values could remain firm - which will likely keep overseas investors from panicking if the dollar falls.)

Conclusions

If the USD heads south, this will benefit high tech exporters, but low tech companies and retail companies will battle a bit in the short term. The economy as a whole does not seem to be too threatened given that inflation seems likely to be controllable as a result of falling oil and pegged Chinese import prices. If yields stay soft this will benefit overseas bond holders but will also benefit consumers - who will, in addition, be given a tax break on two fronts - including double taxation on dividends.

The President has been jawboning the economy up and Mr Greenspan is toeing the line, and all of the above seems to indicate that the equity markets may merely be heading for a period of consolidation prior to a final breakout to the upside.

A bit of volatility to the downside may shake out the speculators in preparation for the commencement of a secondary uptrend (within a Primary Bear Market).

Overall Conclusion

There appears to be no reason to change the "Indian Summer" hypothesis. A benign environment leading up to the US Presidential elections seems to be within the bounds of manageability.

One last question: What about gold?

No change to the hypothesis. Gold itself seems to have bottomed and may stay in a gently rising trend

Gold shares - seem capable of further consolidation around the 60-65 level

Can we make a buck here?

Well, those of you who have the stomach for it may want to play the future's market on the dollar, which seems to have reasonable downside potential. Personally I don't have the stomach for it.


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