Chart wise, the dollar is consolidating and poised to push higher, Gold has made a great run so I’m taking those profits while I have them.  further upside potential from here, at least on a 30-60 day horizon, is limited IMO.  Technically speaking Gold put in a high a few days ago and the dollar is coiling.   The big test will be how Gold puts in its next low.  So far Gold has been making “lower lows” since the $1900 run-up.   If it’s next low is a still lower low (below $1520) it would be a cue that more downside may occur.  Should it make a higher low (above $1520) it would be a promising sign.

Fundamentally speaking I think the ramifications of a Greek default and it’s likely domino effects could trigger Dollar run-up and a vigorous equities sell-off. European default is a deflationary event.  Sure the Fed and Central Banks will try to offset this but in a short term it could possibly result in a Lehman type event.

So the risk/reward here is somewhat asymmetric IMHO.

NOTE: All of this would be negated by a push above $1767

The price action in Gold does nothing to dispel the notion of a deeper correction.  The initial move was swift and a short term bounce is expected.  As shown from the above chart, the correction shows no signs of abating just yet.

The Silver Chart is downright haunting:

A text book bounce off of the 50 DMA, followed by subsequent weakness – not good.  Silver needs to close above the 50 DMA before any thoughts of re-entry are entertained.

This is risk trade.

Risk in PM’s is still to the downside.  From the chart we’d expect a reversion to the trend line as a minimum, while keeping the overall trend well in tact.  The question now is one of risk.  For that we go to the US dollar chart:

Clearly a bounce of some sort is still in order and appears in progress.  A mild bounce should take us to the convergence of trend lines near 78.  A more vigorous bounce would bring us back to the 87 range.  The dollar chart implies further pain the PM’s.

Today’s post is less about forecasting direction and more about managing risk. A look at the weekly chart for the S&P shows the market approaching a key resistance level, it’s 200 week moving average.  Despite the enormous gains since the cyclical bottom of March 2009, the market has yet to break this trend.  With everyone expecting “good things” to come in the form of QE2 we have some disturbing signals emerging.

As contrarians know when the herd runs left, smart money goes right.

UPDATE: With a decisive push through resistance the market is clearly showing it’s hand.  QE2 is having the desired effect (god help us all) and gunning all investment classes higher, clearly putting scenario “A” on the table. An important level has been breached signaling further gains ahead. A successful test of this former resistance would be the cue to add to strengthen long positions.

Resistance

The above chart shows the approach of overhead resistance converging precisely when the ”good news” of QE2 is expected to be announced (Nov. 3).  In the above chart two scenarios are plotted.  While “A” is certainly possible, “B” is the contrarian choice if one were to “sell the news”. Secondary indicators confirm momentum has reached a maximum, indicating overbought conditions.  Unless this momentum is sustained these same indicators will trigger classic sell signals.

NO Fear

The fear index (the vix) is scrapping it’s recent lows at just over 21.  For those not familiar, the vix is a measure of the premiums investors are willing to pay for put options, which act as downside insurance. These low ”premiums”, affected by supply and demand, are effectively saying investors feel comfortable foregoing insurance against a fall in equities. Investors are largely Bullish. Historically this complacency is often a necessary component to market deterioration.

All In

Minyanville contributors enumerate ”10 Warning Signs of a Major Top” citing among other things “[Mutual Fund] Cash has just hit a new record all-time low at 3.3%!”leaving but one direction for that money to flow.

Mish notes Bullish sentiment is at an extreme high (AAII Bull Ration).

So the emphasis is on risk.  While both scenarios are on the table, we are at a potential inflection point in the market. Wise investors would do well weigh any potential upside reward to downside risk.  The best course of action might just be to wait it out.  Cash is a position.

Showing strength in the face of a sharply down market on news of an expanding embargo of Rare Earth Exports.

UPDATE 11/3 :  Having tagged $40 and sharply retracing MCP is now riding the lower trendline of it’s channel.  Watch this trendline for weakness

The Dollar

 Gold

 

It’s important to remind ourselves the difference between Bull and Bear market rallies. Bull market rallies are slow plodding affairs that last months. Bear Market rallies are strong, violent and relatively short. Which profile does this rally fit?

S&P Analysis
The picture is a bit mixed, but from a risk/reward perspective this marks an opportunity to take risk off the table. Trend lines and channels are not some mysterious force controlling the market. They do however show a predictable rate of economic advance or decline while the mood of the market swings from optimistic to pessimistic. Reducing long exposure to the stock market here is prudent for a number of reasons as shown by the chart.

Indicators are leaning mostly bearish but not decidedly so…yet. On the Bull side (green arrows), RSI is still rising and not yet in overbought territory. We are also 1 week into a 20/50 EMA cross. On the Bear side (red arrows) the MACD histogram is showing a slowing of momentum though. And the Stochastics have past the overbought level and deteriorating. Most importantly, we notice the upper trend, where the market currently sits, is meeting significant overhead supply. While the trend line might be pierced it is highly doubtful the market will advance cleanly through this area. More likely it will begin to break down and continue to obey the channel.

Four Bad Bears

(reproduced with permission, courtesy of dshort.com)

When comparing past Mega Bears a couple of things become clear. First these markets all obey a well defined channel. Second, if our current market were turning around it would make it the shortest of the four – highly unlikely considering the economic fundamentals going forward. So while we may indeed poke our head above our heretofore reliable channel it is highly unlikely we will sustain at this level. Balancing risks to rewards it appears we have realized 80-100% of our current move. Don’t let cacophony of optimism loosen you appreciate of risks.