Market rally for risky assets not likely to last long

Friday saw the past week end in a huge rally in almost all asset classes. The S&P 500 [SPX] ended the week at 1362, oil [CLQ2] at $84.84, gold [GCQ2] at $1598.60, dollar index [DXY] at 81.75 and the euro$ [EURUSD] at 1.2658.  Is the rally reactive or is the bull market set to resume, is the key question. Let us take a look at the key markets one by one to answer that question.

Dollar Index [DXY]: The dollar has been in a major uptrend since the beginning of May 2011 from a level of 72.86 and there is nothing to show that this major uptrend has reversed. The dollar made a high of 83.65 on June 1 this year and has been in small but orderly correction since then. The first target for the current correction was 81.50, which was nicked on June 18. Since then the dollar has had a reactive pull-back to a lower high of 83.07 on June 28 from where it closed the week with a sharp fall to 81.56 and then recovering a bit to 81.7530.

The next target for the current correction is 80. However, the huge gap in prices between 80 and 81.50 is likely to act as a major support to the dollar in the coming week. The dollar is likely consolidate just above 81.50 in the ensuing week with a very small probability that it could aim for 80 if the gap looks like being closed. As mentioned earlier, the major trend in the dollar remains up. What we are seeing now is just a correction. Incidentally, yields on the 10-year US treasury notes were a mere 165 basis points but significantly higher than near zero rates on bunds.

Euro$ [EURUSD]: The euro broke a major supportive trend line stretching from 0.82030 in October 2000 to 1.19124 in March 2010. On violating the trend line, the euro made a low of 1.2384, rallied to just under the trend line at 1.26640 before turning down sharply again, closing the week at 1.2658. That is major bearish price action on the charts.

The rally in the euro we saw on Friday is unlikely to last beyond a day or two before it reverses and heads towards its first target at 1.24 and followed by another deeper floor at 1.2150. 

On a more long-term horizon, a retest of 1.19 against the dollar some time by August this year appears likely on the charts. With the violation of the above mentioned trend line, the case for bullishness in the Euro recedes into insignificance. Sell the rallies in the pair.

Gold [GCQ2]: Gold is nearing the end of the first leg of its correction from the top of 1920 in June 2011. Whether the correction will go straight through for another leg or end in a substantial rally depends on the metal's long-term intentions that are difficult to guess at this point. Hopefully the price action in the next two weeks will provide clues to the long-term direction.

From the charts, the rally in gold from 1547.24 to 1598.20 is reactive in nature. This is unlikely to sustain and the metal may head back to the $1550 region again by the third week of July. A decisive plunge below $1550 will be the first indication that the metal may head for a further leg of correction without a rally. On the other hand, a failure to decisively break the $1550 level will indicate an end to the first leg of the correction and a tradable rally from there.

Keep a sharp lookout for the price pattern in the metal for the next two weeks for long-term clues.

Silver: Silver made a low of 26.11 last week before rallying sharply to 27.91. The pullback is reactive and the metal will resume its downtrend again but perhaps not immediately. Any rally will be capped by the huge gap in prices above $30. Expect a period of consolidation in silver between $26 and $30 before the downtrend resumes. The case for bullishness in silver is much weaker than in gold.

WTI Crude [CLQ2]: Crude made a low of $77.69 during the week before rallying to close at 84.96 after making a high of 85.34. The downturn in crude is not likely to last for long. Last week's price action adds to my conviction.

However, the rally on Friday was reactive. Crude could again come down to retest the $75 level before the middle of August. So expect crude to consolidate between $86 and $76 until then. 

Note, the probability of crude sustaining these levels beyond the end of August is practically nil. On the other hand, an early termination of the downtrend also looks unlikely. India has rapidly narrowing window of opportunity to complete oil sector reforms. The government appears hell bent on squandering it.

$-INR: The dollar tested the upper limit of 57.50 against INR before closing the week at 55.50. Note, the $ could test the new floor at 54.50 on Monday or Tuesday but is unlikely to breach it.

On the charts, the probability of the dollar flaring up against the INR during the week to retest 57.50 or even breach it is very high. The period May 29 to July 4 was correction time for the $ to test the new floor at 54.50. That floor was held. Technically, that gives the $ another leg up in the run from 48.5 to 54.50. How far will the $ go in the second leg up and what will trigger it is difficult to say as we are in uncharted territory.

Nevertheless, we must expect another attempt by the $ to make a new in the month of July or the first week of August. That new high could be significantly higher than 57.50. R60.50 looks like one level the $ could aim for by the first week of August if not earlier.

S&P 500 [SPX]: SPX turned down from 1344 as expected making a low of 1309.72 during the week. Then it unleashed a rally that was rather unexpected in strength making a top of 1362 before closing the week there. SPX closed just a notch blow 1363.46, which was the high after the correction down to 1267.16.

The rally on Friday doesn't end the correction in the US markets now under way. From the looks of it and the timing, it appears to be just a sharp reactive pullback and the downtrend can be expected to resume shortly.

On resumption of the downtrend, the first target for SPX will be 1310 followed by a deeper floor at 1267. On the other hand, a close above 1380 will almost certainly end the current correction. While the probability of such a denouement is rather low, the possibility must be taken into account.

Note, the other broader US indices such as the NYSE Composite and the Russel 2000, are not as assertive in their pullback as the SPX. Both present a fairly bearish picture that lends weight to the fact the SPX correction has probably not ended.

SENSEX: After making a low 15,746 on June 1, the Sensex has been in a reactive uptrend. One did not expect it to break above its 200 DMA as it did last Friday. The Sensex closed the week at 17,430 well above its 200 DMA at 17,100.

Does the break above 200 DMA together with the sequence of higher bottoms constitute a breakout or the beginning of a new bull run?

We are towards the fag end of a downtrend where sharp bear rallies are the norm. These rallies often trigger false breakouts. Friday's rally appears to be one such. Having broken above 17,100, the Sensex could head first for 17,900 followed by a higher target of 18,500.

The Sensex has a downward sloping trend line from 20,605 through 18,300 that could meet the rising index in the region of 18,000 to 18,100. The price action in this area could provide more clues to future trend.

On the face of it, it is not advisable chase this rally. Once short covering exhausts, the downtrend will in all probability resume.

The Sensex's downside target of 15,500 remains. 

NB: These notes are just personal musings on the world market trends as a sort of reminder to me on what I thought of them at a particular point in time. They are not predictions and none should rely on them for any investment decisions.