Keeping Things in Perspective, Part II
By Scott McCormick, CMT
In part one of “Keeping Things in Perspective” I focused on the actual returns of the SPX, Gold, and the U.S. Dollar Index. I also alluded to the fact that I have been noticing changes in short term market behavior, the same thing that lead me to conduct a long-term analysis of the SPX this time 2008. Another reason why I feel compelled to look at things from a longer term perspective is because of the type of commentary that I have been hearing regarding Gold and the DX in particular. What I found is important, and could possibly impact all markets over the next three months.
The Standard and Poor’s 500 Large Cap Index, has risen 63.4% in the last 8 months (6 times the current average annual expectation for the SPX) from it’s March 2009 low of 666.79 recovering roughly 50% of it’s overall decline from the October 2007 high of 1576.09. Obviously the trend since March has been up, but relative to the October 2007 high the trend is still down, and we have approached an area that represents relatively little reward for the Bulls, unless it breaks out beyond the resistance levels that we have approached. As trend analysis goes, the SPX has been bumping up against a downtrend line which is connecting the October 2007 high to the May 2008 high. In addition to testing this trendline the SPX is also trading at or near three different Fibonacci levels ranging from 1115.07 to 1135.87 (a closing above 1135 should be significant). The rally since the March low has been accomplished in two swings on the weekly chart. The first swing was from the March low of 666.79 to the May high of 956.23 (roughly 289 points) and the second swing from the July low of 869.32 to the most recent high last week of 1113.69 (roughly 244.37 points). As swing analysis goes, typically you will find that the market will move in swings of three to five waves, and swings one and three tend to be approximately equal in length. If this holds true again the difference between swing one and swing two is now 44 points, or roughly 4% of the SPX’s closing price from November 25, 2009 which would be a target of roughly 1158-1160.
As I pointed out in the performance numbers since October 2007 Gold has been the better performer on a relative basis to the SPX. What is concerning though is that not only is it reaching all time highs, but the trend has been accelerating, which creates a parabolic appearance. When one thinks about markets going parabolic thoughts of Crude Oil in 2008 and the Nasdaq in 2000 come to mind. In comparing the angles of those other parabolic markets to Gold I found that from the Nasdaq lows in 1987 to the highs in 2000 the angle of ascent was 38 degrees (a normal market is closer to 45 degrees). Crude Oil’s angle of ascent from it’s lows in 1998 to its high in 2008 was approximately 31.5 degrees. Currently the angle of ascent of Gold is 33 degrees from it’s 1999 low of 253 to it’s current high of 1187. Now just because the angle is this steep does not mean that Gold is going to stop tomorrow, but since it is trading at an angle greater than 45 degrees it is showing a rather irrational market. In percentage terms comparing the three moves, the Nasdaq rallied 1700% from its 1987 lows, Crude Oil rallied 1300%, and so far Gold has rallied 469% since it’s lows. In comparison to the other parabolic markets Gold looks like it has more to run, which it may, but not without increased risk. One of the tools that I prefer to use to get specific technical levels at which Gold may encounter resistance, in this case, is a Fibonacci extension. Based on swings on the monthly chart going all the way back to 1970, Gold may encounter short term resistance near $1229 to $1256, should the commodity rally through these levels the next cluster of Fibonacci levels comes in at $1458-$1495.
While the focus has been to the upside for the SPX and Gold, it’s is just the opposite for the DX. The DX has been in decline since July 2001, with some interruptions along the way, most notably the rally from December 2004 through November 2005, and more recently the rally from March 2008 through November 2008 and March 2009. Although my focus is on the actual continuous futures contracts of the DX, please remember that it is an index of 6 currencies so when analyzing the DX you have to consider all other components as well. Although it is beyond the scope of this blog the weighting of the Dollar Index is as follows: Euro Dollar 57.6%, Yen 13.6%, Pound (Cable) 11.9%, Cad (Loonie) 9.1%, Kronas (SEK) 4.2%, and Swiss Francs 3.6%. The largest weighted currency is the Euro, and second largest is the Yen. Should the Euro and Yen both encounter resistance it would provide a great deal of support to the DX. As support levels go for the DX the big one is it’s March 2008 low of 71.05, but it may also find support before reaching that level. The first breakout for the DX occurred at 72.64, the second breakout at 74.06 as it worked out of the lows in early 2008. In addition to these price levels a Fibonacci level of 74.95 and 73.12 may provide support. As of this writing the DX is trading below 74.95, but what needs to be watched is whether or not the index recaptures this level without moving to the support levels below it, this would be a sign of DX strength.
So what is all of this saying? I am stating that the current up-trends in the SPX and Gold remain in tack, and the down-trend in the dollar also remains in tack. However all three markets have approached levels that represent higher risk for staying in the trade, than getting out, and as the markets approach resistance levels and support levels it increases the possibility of profit taking in the equity and gold market, and short covering in the dollar. What I mean by increased risk to stay in the trade is this; if you consider your reward to risk ratio in your trade as your trade risk the closer the trade gets to the reward target to more risk is present in a trade. This will cause market participants to seek profit taking opportunities or look for breakouts above resistance or below support levels which changes the dynamic of the reward to risk ratio back into the favor of reward. Having provided the resistance for the SPX and Gold, and the support levels for the DX it is also necessary to know the opposite side of the trend that would indicate a possible reversal, and therefore confirmation of the levels provided. Currently the short to intermediate support level for the SPX is 1019-1029, Gold is 1026.90, and a breakout above the resistance of 76.50 for the DX could indicate again that the markets may be reversing. Keep in mind that in order to reverse an up-trend the market needs to make a lower low and a lower high, and for a down-trend reversal a higher high and a higher low needs to be made. So the levels mentioned should simply raise your awareness that something is happening, not that the trend has actually revered.
