Gold and the U S Dollar Resume Their Trends, Auguring Well for the Market

In the current environment of copious liquidity the Australian central bank became the first to begin to remove the punch bowl by raising interest rates by ¼% overnight on Tuesday. The Austrialian economy, heavily resource dependent, has not been significantly impacted by the financial crisis and rates had only been lowered to 3% in a nod to harmonization with other G20 countries.

World markets took the move as a sign of emerging recovery and strength and rallied sharply. American indices were all up in excess of 1% on higher volume, although NYSE volume remained disturbingly below average, a stark contrast to the higher volume selling last week.

Two of the four conditions we mentioned as necessary for the uptrend to resume asserted themselves today: gold resumed its rise and the U S Dollar its decline. This trade was helped along by news out of the Middle East that OPEC nations are in talks with consuming nations about pricing oil in something other than dollars. While there is likely truth to this rumor oil is a relatively small market and a switch from the dollar wouldn’t be a critical blow to the currency, but it fed the resumption of the trend in sentiment.

Given the moves in the dollar and gold it should come as no surprise that commodities helped lead the market higher. But market strength was relatively broad based, an indication of a more powerful move than we had expected.

Prices on the major indices have now rallied back to their short term downtrend lines, an indication of likely volatility ahead. But while we expect a pullback of some sorts from here we clearly underestimated the eagerness of money managers. Big money is clearly willing to position itself ahead of earnings in an effort to not be left further behind. While we expect good results this earnings season pricing in such outperformance ahead of time will make the market vulnerable to any disappointments, which could well be as simple as guidance that is perceived to be not strong enough.

But be forewarned: betting against the trend in the larger sense is a bad idea until the market gives us clear evidence to consider otherwise. Today’s action tells us it is nowhere close to doing so.

While we have urged caution in our commentary and believed that the correction had yet to bottom, we have been firm in our conviction that this pullback is buyable. If you’ve followed our sister blog you know we’ve been following the market’s promptings and putting some money back to work. We believe stops must still be minded but today’s evidence suggests the bottom of this correction has likely been put in place.