The force behind this move is the Dollar Index, which until now had refused to head higher despite being heavily oversold on multiple counts.

Dollar Index - Daily Chart

If you look the charts of UUP, the bullish dollar index fund, the 1.5% rise for this currency basket has come with a massive buildup in volumes. Also a gap up in UUP after a congestion holds the probability that the gains could stick and could even be a reversal.  A follow through in Friday’ session for the USD would bode well for those rare Dollar Bulls. One thing that is quite clear, if this is not the reversal for the green-back, whenever it occurs, what we saw in yesterday’s session is a mere curtain-raiser of things to come for risk assets.

Looking at the charts of Gold and Crude, there is more evidence that this is probably a turn of high significance for the intermediate to long term.

Gold: The weekly charts of Gold will end up being a bearish outside week (unless it recovers $40 in today’s session) and this high probability reversal has occured at a very important time ratio as shown in the chart.

Gold - Bearish reversal

Crude: A bearish outside week in crude and  Price/Time have squared at the high.

Crude - weekly charts

Dolla Index - Weekly Charts

An ascent past 78.8-79 would increase the odds of this rally having more legs and clearing the 200 MA( currently placed at 81.61). The much awaited correction for the US markets could be close and those emerging markets stocks which have already been battered (like India) are likely to head even lower.

Indian economy barometer

This indicator has a commendable track record over the last 10-12 years:

1) In 1999 – the indicator peaked in Oct 1999, and warned of a bear market a few weeks before Sensex and Nifty peaked.

2) Likewise in 2003 when the Sensex/Nifty bottomed in April, this indicator was a few months ahead signalling an impending new bull market (some might consider Oct 01 as the bottom for the Indices, even then this indicator was ahead)

3) In 2006, during the infamous sharp drop in May this indicator stood its ground.

4) In Oct/Nov 2007, this indicator warned of an oncoming bear market.  The Indian markets peaked in Jan 2008.

It is often a good idea to look at other inter-related markets before coming to a conclusion about a major trend-shift. And here is where the fixed income /bonds come into the picture. Here is a chart of the 10 year OIS swaps.

10 Year Swaps - Daily Charts

As is evident from the chart, there is still an intense struggle to cross the 200 DMA. AND when stock markets were trading near the all time high, the 10yr swaps were actually miles away from the peak made in February!  If stocks are that attractive why are investors still seeking the safety of fixed income?

I have for quite some time held that the continuation of this bull market is largely dependant on the debasement of the USD. Which was exactly why I had stressed the importance of staying  near the door of the bullish camp and having price objectives as opposed to a price target (see CNBC interview) on emerging markets, Gold, Silver and other asset classes. That brings us to the chart of the Dollar Index:

Dollar Index - Ichimoku charts

Not only has the Dollar Index reclaimed the key level of 80, it has also punched through the cloud resistance on its daily charts. If  my reading of the wave count here is correct, what we saw between QE2 day and Nov26th was just a milder part of the Dollar Index rally. The stronger portion of the rally has just about begun! ! (Remember the tight inverse correlation between emerging markets/commodities here and here?)

In 2010, emerging markets have had 2 significant corrections prior to November. One in Jan-Feb and the other one in Apr-May. The gross short interest in MSCI EM was 15% lower at November peak when compared with the January peak. That is a substantial level of complacency!!

MSCI EM Gross short interest

Let us also look at Gold which can give us a fair idea of inflationary/deflationary pressures in the global economy.

Gold Daily Charts - A potential H&S top?

The daily charts of Gold shows us that the swing to 1425 is in disagreement with the momentum readings. We can also see the potential for a Head and Shoulder top formation.  A close below the neckline, currently at 1340, is likely to augment further selling and a minimum drop to 1225 level is the expected outcome of such a breach.

Dollar Index - Daily Charts

The daily charts of Dollar Index shown above, the drop from October lows to November lows is not matched by a momentum drop. This kind of positive divergence is usually a precursor to a trend change.

Powershares DB US Dollar Index Bullish Fund

The UUP charts shown above, a morning star candlestick pattern is visible.  When this pattern occurs it is usually a strong reversal sign.

Also, I can count 5 wave decline to the November lows and Sentiment readings from Trade-Futures are pointing to a very extreme level of bearishness for the dollar index (hence bullish from a contrarian  perspective).

So what does all this mean for the other markets? Commodities and stocks closely tied to commodities are very likely to be the immediate victims. The daily correlation for equity markets with the Dollar Index, though varies now and then, currently stands at a range of -ve 0.83(for S&P)to -ve 0.94(for NSE Nifty) i.e. a very high inverse correlation. It is pertinent to note here that such a high inverse correlation existed for equity markets in November 2009 and when the Dollar Index started a powerful rally in December, a correction in equity markets commenced not until January. So a correction or a trend change in equity markets may either be immediate or may start with a slight lag depending on the strength of the anticipated USD rally. Stay cautious and watch how the markets pan out over the next few days.