How I'm Trading Stocks, Gold and the Dollar

On November 11, the S&P reached 1105.37. Since then, the S&P has traded in a fairly tight range between 1085 and 1,115, with a couple of very brief spikes to 1117 and 1119. The price pattern since November 11 appears to be forming a five point (a, b, c, d, e) expanding triangle. Today's drop below Friday's low of 1096 could be providing the finishing touch to wave e of the expanding triangle. Unless the S&P closes below 1080, which has been my expectation, the completion of the triangle implies that the market will rally above the resistance around 1115. This rally would have the potential to reach 1145 to 1165. If this rally develops, it is likely to represent the end of the rally from the March low. The bottom line is that the market is at an important juncture.

The Russell 2000, which has been consistently underperforming the DJIA and S&P since mid October, has been gaining in relative strength. This shift appears to have coincided with the improving tone in the dollar. A weak dollar helps companies with international exposure, since the 500 companies in the S&P garner 45% of their sales from overseas. The combination of a stronger dollar and the better than expected jobs report on Friday has led to a swing toward domestic oriented companies that are in the Russell 2000. If the triangle interpretation is correct, the Russell will likely outperform, if the S&P moves above 1115.

In last month's letter, instructions were given to cover half of the position in (NYSE: TWM), which represents a short of the Russell 2000, if the Russell traded above 606.00. The Russell did trade above 606.00 on December 4. Close out the remaining 50% position in TWM, if the Russell trades above 606.20. Instruction were also given to buy SDS, which is the S&P short ETF if the S&P rose above 1105.37 and add if the S&P exceeded 1115.00, using 1130.00 as a stop. Lower the stop to 1111.00.

DOLLAR

On December 4, the dollar broke out of a downward sloping channel that had contained all trading since August. A push above 76.26 will increase the odds that an intermediate low in the dollar has been established. The dollar topped within days of the stock market's low in early March. If the dollar is embarking on a meaningful rally in coming months as I believe, the stock market will likely decline, along with gold, oil, and stock markets around the world. We are long the December futures from under 76.40 and will roll to the March 2010 contract. We are long the dollar ETF (NYSE: UUP) from an average price of 22.40. Maintain the stop at 74.00, which will be adjusted once we roll to the March contract.

GOLD

The recent $80+ decline in gold, after an almost vertical run, suggests at least a short term top has formed. Given the extraordinary bullish sentiment toward gold, many gold bulls will look at this drop as a gift, so expect a sharp rebound in coming days. This will be reinforced if the S&P breaks out above 1115.00.