Dollar breakdown could fuel Santa Clause rally in US stocks & precious metals

The US dollar, as measured by the US Dollar Index, has broken down out of a significant uptrend that began in mid-September. The move is potentially very bearish for the greenback and a sizeable drop from here could fuel a decent Santa Clause rally in stocks, commodities and precious metals.

The US Dollar Index measures the value of the US dollar relative to a basket of foreign currencies, including the Euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and the Swiss franc. However the index is heavily weighted towards the Euro (some 57.6%), and thanks primarily to renewed problems in the Eurozone, the Dollar Index began a powerful move up in early May 2012.

After a pullback in June it continued its advance making a new high in late July. However the new high was not confirmed by the MACD (Moving Average Convergence-Divergence) indicator which showed negative divergence, something which often signals that a trend-change is underway. The dollar then began a powerful decline, finally bouncing on 14 September at 78.60.

As the chart below shows, the dollar then began to form a significant uptrend channel that saw the world’s reserve currency retrace 50% of the decline, before running into resistance on 16 November at 81.46.

The decline that followed the 16 November top initially found support at the 50-day moving average (blue line) and then the lower uptrend line (dotted blue line). However yesterday’s decline saw the dollar break (and close below), the 50-day moving average and then the lower uptrend line (red circle).

The Dollar Index also closed below the psychologically significant 80 level.

A 1 year chart of the US Dollar Index (Click on the chart for a larger version)

A 1 year chart of the US Dollar Index (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

Since all commodities and precious metals are denominated in US dollars, a declining dollar provides these assets with a boost, and the same goes for US stocks.

The next support level for the dollar is well below the current 79.88 price, and if the greenback is unable to find support at around 78 it could fall all the way to the 2011 low of 72.70, likely fuelling a decent Santa Clause rally.

As the chart below shows, the US dollar is in a long-term, secular decline, and with the US central bank’s recent announcement of QE to infinity it seems likely that the dollar’s decline will continue.

A 12 year chart of the US Dollar Index (Click on the chart for a larger version)

A 12 year chart of the US Dollar Index (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

How to profit from the decline of the dollar

Those looking to profit from the decline of the US dollar could consider going short the currency via a spread bet. Watch for a retest of the broken downtrend line at around 80.13 as this level should now act as overhead resistance.

As always, a stop loss (placed at around 80.45) should be employed to limit losses in the event that the trade goes against you.

  1. Will High-Frequency-Trading (HFT) Bots Be The Fuel That Drives The Santa Claus Rally?
    Well it would seem so from this really great blog post by Carl Weiss from sceeto a high frequency
    trading expert
    http://sceeto.com/blog/will-high-frequency-trading-hft-bots-be-the-fuel-that-drivesthesanta-claus-rally/

    High Frequency Trading has been causing havoc for years in the financial markets. It was very
    interesting to if you look at a few weeks ago when President Obama was elected just how the markets
    or hft’s showed their displeasure by plunging the market almost straight away on the news. Obama
    had talked about more regulation on Wall Street, were they trying to express their displeasure with the
    announcement?Check out the video here http://youtu.be/N1ouo0aeO7o . The downward moves have
    been consistent right up to when the tops execs met with the President recently when , amazingly but
    I guess not surprising the markets start to rally up pushed by high frequency trading.
    One with assume everybody at the meeting perhaps decided to play nice and try and lift the markets
    especially considering all the negative talk about the fiscal cliff. I would tend to agree with Carl that
    indeed High Frequency Trading will be the fuel that pushes a Santa Claus Rally as their is a lack of
    downward hft pressure the last number of days which is unique.Where the markets go after this is over who knows but expect High Frequency trading to play a big

    part in it as always.

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