Dollar’s Move Relative to Commodities Bearish for Stocks
It is common knowledge for market participants that all things being equal, a strong U.S. dollar tends to be bearish for stocks and commodities. Stocks (SPY) and the dollar (UUP) can rise in unison, but it is not as common as having them move in opposite directions.
Commodities (DBC) have two major investment components: (a) as materials to make goods, and (b) as a currency alternative to fiat or paper currencies. When commodities are in demand, it can be a reflection of a strong economy. Rising demand for commodities can also signal inflationary forces and winning out over deflationary forces. If you own stocks or commodities, deflation is not your friend.
What are these markets telling us today? The short answer is “be careful”. The chart below shows the U.S. Dollar Index relative to the CRB Index (commodity basket). It is obvious the trend in the chart below was down from mid November 2010 until late April 2011, which tells us the dollar was weakening relative to commodities.
When the dollar began to strengthen in late April, it was not overly concerning since countertrend rallies are common and do not signal a change in trend. A fairly reliable way to look for a possible change in a trend is to look for three things (see chart below). At point 1, the ratio broke above the downward sloping trendline. At point 2, a higher low was made relative to the previous low. The trifecta was completed at point 3 when the ratio made a higher high.
The change in trend above is not the end of the world since it could be short-lived, especially since the dollar’s 200-day moving average may come into play soon, acting as possible resistance. However, it does signal a meaningful shift in demand for U.S. dollars (“safe haven”) relative to commodities (economically sensitive). The current trend is deflationary, which is a yellow flag for asset prices. As long as the current trend remains in place, we will err on the defensive side in terms of holding cash and raising additional cash.
Looking at a more bullish chart, the ratio of the dollar ETF (UUP) to the gold ETF (GLD) has not seen a change in trend. However, the Rate of Change (ROC) indicator, shown at the top of the chart, has completed all three steps needed for a change in trend. The move in ROC may be foreshadowing a change in trend for the ratio, which leans bearish for stocks and commodities. Silver (SLV) is in the same boat with the third step not yet completed relative to the greenback.
As of the close on Thursday, the S&P 500 was trying to make a stand above its 200-day moving average. A break below the 200-day, which sits at 1,263, could trigger numerous sell programs. From a bullish perspective, if the market can hold above the 200-day and show some strength, it may bring some cash off the sidelines since buying near the 200-day tends to be a good risk-reward trade during a bull market.
