Why This The Most Opportunity-Rich Trading Week of the Year
Before I dig into the charts this week, I want to refer you to my last weekly email. This was last Sunday and the tagline was “Dollar Spiral”:
I'm not pointing this out to crow about my prediction that came to fruition.
Instead, I do want to point out that I made this call based on price action. I’m a firm believer that price action incorporates the news and points the way the market wants to go.
And as I’ve said repeatedly in recent weeks, we’re at an inflection point with the US dollar. That’s why I keep showing you this 45-year chart of the US Dollar Index (USDI):
I want to put things in perspective so you can see what’s happening in the short and the long term.
And in this 45-year chart, we can see that over the last 10 years from 2010, the dollar had an enormous rally which took the Euro from 1.60 to about 1.03.
However, the legs of this dollar rally are being chopped out and lower prices are on the way. More on that in a moment, but note that despite the massive 10-year rally, the USDI high is still well below its high in 2000 and that high is much lower than the one in 1985.
This sawtooth pattern in USDI means that the overall trend is down despite the enormous, periodic rallies. And what’s more, I believe we’re about to see another slide lower. This is not only important for us as traders. It also has ominous implications for the world economy at large.
I want to talk about that for a moment.
Here’s a chart that plots gold against the dollar and 5-year bond yields too:
While the dollar has been plummeting, gold has been skyrocketing. Meanwhile the blue line is the five-year bond yield (i.e. it’s tracking interest rates), and it’s been heading much lower too.
This is an omen of something called stagflation. Stagflation last happened in the 1970s and it was not a good time for the economy. We had the extremely undesirable combination of sluggish, slow growth (including high levels of unemployment) coupled with expanding inflation.
This is an awful thing for the economy and most everyone in it. It's potentially an awful thing for investors too, but only if you don’t understand what's going on.
Gold soaring suggests that it’s starting to price in a stagflation economy. That’s one where interest rates go down, where there’s very little growth, and gold rallies as a safe haven amidst the storm of uncertainty and fear.
The main driver behind gold is that real rates continue to plummet and don't show signs of easing up anytime soon. That’s because all the world's central bankers are coordinating a drop in both real and nominal rates.
(Nominal is the “headline” interest rate whereas the real rate is the nominal rate adjusted for inflation. So if the nominal rate is 1% but the inflation rate is 2% then the real rate is actually -1%, just to give you an example.)
There’s no indication this interest rate trend is going to turn around with the backdrop of the pandemic and the associated worldwide economic slowdown. So all this is going to have a real consequences, for the dollar, the stock market, and alternative investments such as gold and silver too.
Now I'm going to try and unpack all of that by looking at each chart individually.
Let’s start with the weekly chart of the USDI:
That huge long-term downtrend on the 45-year chart has truly reasserted itself. The double top we saw on the 45-year chart is visible here too. Plus there are other bearish patterns to add weight to the bearish case.
At the height of the pandemic fears, USDI thrust a hair above old highs and created a bull trap for anybody chasing dollar-correlated investments. Everyone caught long above that line is now losing money, and a lot of it, unless they get out of their position by selling.
The index not only collapsed below its old resistance/support line (marked by the first top of the double top), it also dropped below its long-term support line just last week.
There’s also a bearish head and shoulders pattern with the recent bull trap as the head and weak rallies on either side as the shoulders.
Because a head and shoulders is a reversal price pattern, this strongly implies that USDI’s recent 10-year uptrend is over. Currently the index is about to thrust below the neckline for that pattern.
And once that happens, it should open up a huge move lower. It’s just a matter of time. Perhaps there will be a re-test of that neckline once it’s broken. If it happens, that's where I would load up the money truck. But we may not get that retest. The market will decide, not me.
Regardless, it's not a question of if, but when, the dollar falls.
Now here’s the upside-down version of USDI, otherwise known as the EURUSD (the Euro versus the U S dollar):
This chart is the inverse of USDI because the Euro comprises over 60% of USDI. So if our expectation is that USDI is going to fall, then the Euro should rise against dollar. And that's exactly what we've seen.
EURUSD has traced out a long-term Adam and Eve double bottom where Eve is comprised of multiple rounded thrusts at one support area and the Adam bottom is a single thrust. This looks like a long-term basing action and the bigger the base, the bigger the move up into space.
There’s also an inverted head and shoulders in EURUSD, one with a sloping neckline.
A sloping neckline indicates EURUSD will go even further and faster than if the neckline was flat, as with a more conventional head and shoulders. That’s why I’m thinking we’ll see an explosive move higher in the coming days, weeks and months in EURUSD.
For comparison, here’s GBPUSD (the British pound versus the U S dollar):
The British pound has been in a 10-year downtrend that took it from 2 to about 1.15 during the crisis. That downward ‘crisis spike’ looks very much like “bear trap” behavior, where sellers got short under the key support areas and then got caught if they didn't cover their positions quickly.
GBPUSD is now starting to threaten its long-term downtrend line and any penetration above this line will start a reversal of that trend. In the meantime, GBPUSD has traced out an Eve and Adam double bottom to form what looks like a huge base from which to launch a prospective bullish trend.
There are still some critical price thresholds to overcome first. But to my mind, any sustained push above resistance at 1.32 will indicate the demise of GBPUSD’s long-term downtrend.
Now as regular readers know, for the past several months and even years, I’ve felt the best risk/reward trade on the board is being short USDJPY (the US dollar versus the Japanese yen).
There’s a symmetrical triangle here and USDJPY is just about to penetrate below the lower edge of this pattern.
Within the triangle there’s several bear price patterns, starting all the way back in 2015 with a double top emerging as part of a head and shoulders. We’ve since seen a much more recent double top that’s turned out to be part of another head and shoulders pattern, which strongly suggests USDJPY will go lower … soon.
In my mind USDJPY took out a key support level this part week as it dropped a hair below 106. This opens a path to 104 support and then the pandemic lows around 100.
Ultimately, I think USDJPY will kick the doors below 100 as the dollar weakens significantly. Any rallies in USDJPY should be used to initiate or build a short position before the descent begins in earnest.
Now for a pair I haven’t talked about much for quite some time …
In this chart, I'm looking at EURJPY (the Euro versus the Japanese yen) which is very instructive for a number of reasons.
When I look at a chart, I’m always evaluating what appears to be the dominant or governing pattern. A governing pattern defines the market’s path going forward until it/they are finally busted by a new governing pattern that acts in opposition.
However, the market can be like a magician in that it sometimes hides its intentions. It doesn't just come out and pull a rabbit out of the hat. Instead it distracts you with one hand while pulling the rabbit out of the hat with the other.
That’s why we have to stand back and determine what the market is telling us. In this case EURJPY is a bit confusing right now.
On balance, EURJPY looks very bearish by virtue of long-term patterns such as the head and shoulders and then the double top. Once the price broke below the neckline of the double top, it suggested that even lower prices were on the way.
However, that hasn’t really happened. It might – the market could be tracing out another double top right now with its most recent rally.
Yet EURJPY has been a lot firmer than I would have expected. Now it seems that a bullish double bottom is stacking up.
So is the governing pattern still the head and shoulders and the double top? Or is the newer double bottom the new governing pattern instead? The recent price action is convincing me of the latter, although I’m still happy to let the market be the referee here.
If we see stronger price action, then it makes sense to ride EURJPY’s emerging bull trend. This is how I’m inclined to bet right now.
But if prices can’t hold up, then my original bearish bias will be borne out.
So I hope this helps you see how to balance competing (and opposite) views on the future direction on a chart. If in doubt, go with the price action that seems to confirm the old (or new) governing price pattern the most
Now let’s look at the precious metals, starting with XAGUSD (spot silver):
Silver’s had a massive rally from $11 all the way past $25, therefore more than doubling in only a couple of months. To my mind, this is a warning shot across the bow to all kinds of asset investors around the world.
Gold and silver have been going up because interest rates have been cratering. Typically, gold and silver don’t pay you any return, but right now neither does anything else. The precious metals no longer have to compete with the interest rates on other investment assets.
On top of that, we're seeing China's GDP converging to US levels thanks to the widening gap in COVID-19 cases. This could indicate a geopolitical shift of tectonic levels and further supports the case for much more upside momentum in gold and silver. A decade ago, the economic crisis was all about the banks and the toxic assets on the bank's books. Now it's a much wider and more encompassing economic crisis, one with the falling growth and potentially rising inflation, e.g. stagflation as I mentioned earlier.
For a long time, I’ve been looking silver within the context of its long-term descending triangle. It kept making lower higher which is bearish.
On the other hand, the coronavirus panic that triggered the $11 low set up a what looked like a bear trap. Since then, bullish momentum in silver has continued to build, creating a giant short squeeze for all the short investors who based their trading on that descending triangle trendline not getting broken.
Now that six-year downtrend line has in fact been shattered, there’s also a very powerful inverted head and shoulders in place. Silver crossed the neckline of that pattern last week, which opened up a path for the current explosive move.
I would love a retracement to happen in silver.
That would let me go long on larger positions than I already have. But I don't know that we're going to see it. The momentum is clearly on the long side and silver is threatening to take out successful multi-year resistance levels with a vengeance.
So it looks like there's an enormous amount of blue sky ahead for silver. I think the next real resistance levels will come around the $32 to $35 area. The starting gun has been fired and silver looks to have truly embarked on a bullish run that could last for weeks, months, and possibly years.
Let’s see how XAUUSD (spot gold) is doing in comparison:
Gold is a great indication of how price is ahead of the news. All the way back in 2015, gold bottomed out at about the $1,050 area. In addition to the double bottom, gold traced out what eventually proved to be a complex inverted head shoulders (it’s “complex” because of the multiple shoulders on each side of the head).
The common neckline that runs through the entire pattern was at $1,360 where (as I said at the time) any breakout would open up a huge path higher in gold. As with EURUSD, “the bigger the base, the more into space.”
And that's exactly what we're seeing in the price of gold today. But again, the entire bottoming pattern was forming well ahead of current events.
And this is why price is such an important indicator. Price is always ahead of the news because the market is a discounting mechanism. The virus unleashed a torrent of forces and fuelled relentless demand for perceived safety. There's also a fear of further government-ordered lockdowns and political decisions to push through unprecedented stimulus packages including central banker decisions to print money faster than we've ever seen before.
Yet gold was beginning to price all that turmoil before it became “official”.
And now it looks like the yellow metal has taken out is major multi-year resistance area around the $1,800 area. As with silver, it looks like nothing but blue skies above for investors. There’s going to be volatility, but I would use pullbacks in both gold and silver to establish long positions over the long term here.
So how are the US stock markets doing amidst all this?
In this chart, I'm looking at the NASDAQ, which is the proxy for the US tech sector:
In the last couple weeks, this index has traced out two big, bearish key reversals. This is when the market makes a new high but then closes near the lows of that bar, meaning that at the end of the week, the sellers were in control.
These reversals are potentially ominous indicators.
I don't think that prices are immediately going to come crashing down. But I think they’re telling us the NASDAQ has reached a short-term peak.
Also notice that the NASDAQ has thrust above its old highs in January and February. (The other two major US stock indexes haven’t done so and have therefore failed to confirm this NASDAQ breakout.)
Meanwhile, the NASDAQ managed to barely peek above the upper side of a very large ascending, broadening price formation. Then it fell back inside. This suggests it could be a bull trap up for anybody who played this market above the long-term resistance line.
So all in all, it does look like this index will drop somewhere back inside the ascending broadening formation, and probably to the resistance line if not below. After all, there’s been a huge run up in the market and therefore a pullback and some consolidation isn’t out of the question.
The giant amount of volatility that's occurred during this run up also suggests that speculators have been getting quite emotional. This too could also indicate at least a short term peak in this market.
Now here’s the S&P 500, which has also traced out a few reversals lately:
Last week the S&P traced out a bearish key reversal, but this is counterbalanced by several bullish key reversals in earlier weeks.
While the latest development may have established a short-term top, this market still looks like it has upside momentum.
In the meantime, it’s still trading within the confines of a reverse symmetrical triangle, sometimes called a megaphone top. If this does turn out to be a top, the S&P would be destined to fall to and penetrate the lower trendline of this triangle.
However, I don't see that right now. The bullish key reversals supporting this market look strong enough to ensure that prices won’t come tumbling down ... yet. I don't think it will be that easy.
As with the NASDAQ, my expectation is that the S&P could find itself mired in consolidation around current levels in this chart.
Finally, here’s the DJIA (the Dow Jones Industrials) which is similar to the S&P500 in that today’s highs have failed to exceed the January highs:
This is what's called a bearish divergence with NASDAQ, as the NASDAQ’s all-time highs have not been confirmed.
The DJIA has another similarity with the S&P in that it’s traced out a reverse triangle / megaphone top and that it too is dealing with some bearish key reversals. The DJIA is presently stalled out.
For now I’m pretty much on the sidelines here with US stocks. Even if we’re in a market top situation, it should take a little longer to start rolling over. And the market could still go either way thanks to residual upside momentum.
That's a dangerous place to be. So if you're inclined to take some bets on US market indexes, keep your risk low.
In the meantime, I remain bearish on the US dollar and therefore I’m bullish on EURUSD and bearish on USDJPY. I’m tentatively bullish on EURJPY and very bullish on the precious metals. In fact, both silver and gold look to be ‘blue skies’ trades and any weaknesses are buying opportunities.
I wish you a very healthy and prosperous trading week.
Mark "GlobalFearFactor" Shawzin