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Dollar rally faces headwinds; may provide strength to equities, commodities

17 December 2011: The US Dollar has reached a long term area of resistance which is likely to end the greenback's rally and result in a reversal, or at least a correction.

A fall in the US dollar will augur well for risk assets such as equities and commodities. At this point in time, many experts say the dollar will continue it's march up. Many of these experts make their predictions after asset classes have made their move and are close to reversal points. It is very difficult to take a contrarian position when the market is rocketing up or down. But it's precisely when markets are at turning points that they are most bearish or bullish. It is also the best and most scary time to take the contrarian position.

A fall in the US dollar will augur well for risk assets such as equities and commodities.Reuters

The dollar is in such a position now and charts say this is not the time to go long, and a low risk time to go short. The dollar index, which measures the greenback against a basket of six major currencies, is reaching its 2011 highs from where it had sold off in January of this year. The level of resistance is between 80.75 and 81.50. The index touched 80.73 last Wednesday and sold off a bit. (Click here for dollar index chart)

The dollar neared the 80.75 level after breaking through a lower resistance level of 79.90 that we have mentioned in earlier articles. The two resistance levels are close to each other, which makes the higher level - where the dollar reached this week - a better selling or shorting level.

The reason is simple. Resistance levels are areas where the number of sellers exceed buyers, due to which prices often fall. The first time prices reached the 79.90 level in September this year it had a strong fall. The second time it reached there in November 2011, it again had a small fall. The index then rose again broke above the 79.90 level to now reach the 80.75 area.

Now, let's go one step deeper in our analysis. For prices to rise above an area of resistance, the buyers have to buy out all the sellers. This reduces the number of buyers. As prices head higher to the next resistance level, the number of buyers are falling and the number of potential sellers (who are present buyers) are increasing. So when prices hit the next level of resistance or excess sellers, prices have a much higher chance of falling as the number of buyers are substantially depleted. That's where the dollar index reached this week.

The resistance zone for the dollar is between 80.75 and 81.50, and it's possible that prices may go into the range before dropping. In case the index breaks above this resistance zone, it's next target is at the 83.25 area. The resistance zones are marked by red horizontal lines on the chart. Interestingly, the indicator Commodity Channel Index, has not yet given a sell signal. Conservative traders wait for the CCI to go above 100 and then fall below 100 to sell. At the time of writing this article, the CCI was falling but still at 106.

The potential fall in the dollar index is likely to benefit gold, silver and copper more than equities or crude oil. Crude oil is already rallied a lot which means the upside potential is not very high. Gold and silver on the other hand has sold off a lot giving it more room to rally. In fact gold touched a wide support zone this week and rallied. The zone is marked by green horizontal lines on the gold chart (click here for the gold chart). Silver too came near it's support level as shown by the green lines on the chart and caught a bounce. Silver however did not touch the support zone, but rose given the weakness of the dollar (click here for silver chart)

Copper on the other hand entered its support zone and bounced as shown in the chart. The support zones are marked by the two horizontal green lines. If copper reverses and falls and dollar goes deeper into its resistance zone, the metal can fall to reach the level shown by the white lines (click here for copper chart)

Keep an eye on copper, as a rally in the metal can push equity prices up. The equity markets often follow copper.

George Albert is Editor, www.capturetrends.com