Negative Divergences On The Dollar Forecasted Trend Change

Last week I warned that the US dollar was reaching three-year lows and to expect a dollar bounce. The dollar has bounced higher as risk aversion has returned with Ireland on the verge of needing a bailout and China raising interest rates to combat rising inflation. There are growing concerns of the Fed needing to raise interest rates ahead of schedule. The previous euphoria in commodities appears to be waning and the technicals are demonstrating the fundamental challenges facing commodities.

There are negative divergences of momentum and price on both the dollar and gold to indicate counter trend reversals may be developing. I have alerted to be 100% defensive since the November 9 high volume reversal. (See Fed Creates Parabolic Move in Gold, Silver)

Understanding momentum gives a trader clues that the trend may be changing ahead of the actual trend breakdown. Divergences in momentum signals the enthusiasm may be receding and the attitude of the crowd is changing.  At the beginning of a new trend there is a lot of excitement, but as the price continues higher demand weakens to the point where a major reversal occurs. Just like when you throw a ball into the air, the initial force wears off until it reverses direction and falls back. This loss of upward or downward momentum is being signaled in both the dollar and gold. Momentum changes trend often ahead of price.

A new low was made in the US dollar after the election and the Federal Reserve’s QE2 announcement. However, the momentum didn’t confirm the new low made as it made a higher low on the RSI and MACD. This signals that the downtrend may be ending and that may have been an intermediate low.

Negative divergence between momentum and price forecast further weakness for gold. Unexpected by many, the dollar is appearing to be the winner of the QE2 trade. Jesse Livermore said, “The smarter they are the easier the market fools them.” At the top in gold and the bottom in the dollar, the smart and easy trade was the wrong trade. Being long the dollar at a time when $900 billion is poured into the market is highly counterintuitive.

The dollar has bounced higher as risk aversion has returned with Ireland on the verge of needing a bailout and China raising interest rates to combat rising inflation. There are growing concerns of the Fed needing to raise interest rates ahead of schedule as Treasury prices have had a bearish reaction. The previous euphoria in commodities appears to be waning and the technicals are demonstrating the fundamental challenges facing commodities as momentum deteriorates.

The dollar broke through its five-month downtrend as investors are concerned of an Ireland bailout and emerging markets raising rates to combat imported inflation. Now we’re seeing political opposition to the Fed’s last move to pump $900 billion into the economy.

Gold at the time of the QE2 decision was perceived as indestructible as investors worried about a currency devaluation war. As targets were being reached I issued a sell signal and cautioned about getting caught up in the euphoria. I had the four-word famous response, “This Time Is Different.” It was at this point in the precious metals rally where the rain clouds began getting dark beginning in late July. As bottoms and tops take time to form, patience is required when issuing a sell or buy signal. A top is now being confirmed as trendlines are being broken.