Equities are in conflict with dollar, gold and bonds

By George Albert

The equities market is like a Formula One racing car… fast moving, exciting and with the ability to provide instant gratification. It’s for this reason many traders and investors are attracted to equities. Then there is the dollar, bond and gold markets. If the F-1 car is the equities market, then dollar and gold are the current drivers.

The sages of trading and investment often watch these markets for clues on the direction and strength of the equity markets. ( View Chart ). So, as the equity markets were rallying over the past few days, just as we had predicted, the gold and dollar markets were giving conflicting signals. Last Friday, the equity markets smacked into a wall of resistance and led to a selloff, both in India and the US. 

Fundamental analysis assigns the poor jobs report in the US as the reason for the selloff in the US. However, the other markets and the equity markets themselves were indicating that a fall was imminent. The US markets had reached resistance - an area where the supply of stocks exceeded demand. The Indian markets, on the other hand, were nearing the upper end of a symmetrical triangle which often acts as resistance. There is more on the symmetrical triangle below.

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The probability of a selloff was high given the signals from the dollar, bond and gold markets. The equity markets and the dollar, gold and bond markets are generally inversely related. This means that the three markets move up when the equity markets fall and vice-versa.

The reason for this is simple. The equity markets are risk plays, while the three other markets are safe havens. When risk appetite increases, money flows out of the gold, bond and dollar markets to the equity markets, leading to a fall in the three markets and a rise in equities.

The recent equity rally was not followed by a fall in the gold, treasury or dollar markets. On the contrary, the three markets rallied with equities, making the rise suspect. On 27 June, the equity markets, as shown by the S&P 500 futures contract chart, began to rally.

However, on 1 July, the US treasury bond market began to rally too, casting doubts on the equity rally. See the chart of the 10-year treasury bond nearby. ( View Chart ). On the same day, gold ( View Chart ) stopped falling and began to rally and the dollar ( View Chart ) began its rally on 3 July. The dates are shown by vertical lines on the charts.

Interestingly, the equity markets, both in India and US, sold off on Friday on hitting major resistance. Resistance areas are levels from where prices turn and fall. However, none of the other three markets hit resistance. If these markets continue to rally towards resistance, we could see a further drop in the equity markets.

The poor employment report cast a gloom in the US markets, which can spread to other global markets. There was a good correction to the fall in the US markets at the end of Friday due to an increase in consumer debt. An increase in debt levels indicates that the US consumer is spending again. So the markets are still undecided.

The trading strategy we’d adopt is staying short on the Indian and US equity markets for the short term. Unless the Sensex breaks out of its symmetrical triangle, we’d not take a long term view of the market. ( View Chart ). In a symmetrical triangle, the price moves in a continuously narrowing range as buyers and seller battle to give market direction, but fail. The narrowing range forms a symmetrical triangle when we connect the peaks and valleys in price.

Once prices break out of the triangle they usually have explosive moves. Right now, copper is stuck in the triangle as shown in the graph. If the index closes outside the triangle on the downside, prices will head lower. On the other hand, a close above the triangle’s borders will take prices higher. But since symmetrical triangles are continuation patterns, the greater likelihood is that prices will head lower.

Long term traders tend to avoid asset classes moving inside a symmetrical triangle. They take positions only after prices close outside the triangle.

Since the gold, dollar and bond markets are between major support and resistance, we’d leave them alone.

George Albert is based in Chicago and edits capturetrends.com