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Dollar, gold, oil and the Dow 10,000 double-top

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With US employment now officially in double figures there is plenty of reason to review the outlook for the world’s biggest economy, and plenty of cause for concern about the much trumpeted road to recovery.

At the same time the Dow Jones Index is showing signs of a classic double-top formation at the 10,000 mark. Quite what has justified such euphoria from the March lows is not clear, but a 50 per cent surge since then certainly puts the price-to-earnings ratio in bubble territory (see graph).

Market volatility

This seems to be an unwelcome side-effect of super-low interest rates. What goes up so high will have a big fall. Higher volatility comes with this market distortion, and investors should watch out below. Does that p/e graph not look like a very clear spike?

Invest now and you are taking a huge risk on continued upside, while the downside position is only too obvious. Anybody who has through luck or judgement ridden this rally ought to sell out now.

The falling stock market will take gold and oil down with it, and money will be exchanged into dollars which will rise in value as a safe haven asset.

But gold at $1,100 has established a price-floor above $1,000 an ounce and should not suffer anything like the same catastrophe as last autumn, and silver will keep the yellow metal company as a precious metal rather than an industrial commodity.

Oil prices look vulnerable around the $80 mark and a sharp pullback is likely. Thereafter the trend for oil depends on what happens to the Dow Jones.

Oil price fall

A short correction would be mirrored in the oil price. A more realistic pull back in the Dow to reflect the profits outlook in a world of high unemployment, low consumer demand and slow or no growth, would take the oil price below the $34 of last December with a bounce to no more than $50.

But the biggest damage from a large slump in the Dow Jones would be to the financial sector that was bailed out in 2008-9. Then the future of many firms would be imperiled and as the CIT group’s experience shows there are plenty who are small enough to fail.

So the rational trader might go into dollars and gold, and short US stocks, particularly the financials, and also short oil. The Dow Jones at 10,000 is a double-top sell signal that could be confirmed as early as Monday. The S&P financial stocks closed lower on Friday, an ominous sign.

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Written by Peter Cooper

November 7, 2009 at 8:23 am

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