By Jim Donnelly, Olson Global Markets

Along with likelihood that the U.S. Dollar Index (DXY) has more room to move on the upside, it also appears that the converse of that thought is likely as well. Namely, that the Philadelphia Gold/Silver Sector Index (XAU) has more downside ahead of it.

After hitting a high of 198.32 on December 2, 2009, which tested key “channel top” resistance, the XAU reversed direction and later sliced below “mid-channel” support at 164.10 on January 21, 2010. With long-term (monthly) stochastic studies still falling bearishly at this time, the prospect for a test of key “channel bottom” support at the 138 level appears probable over the next couple of months. Moreover, by the time such a test occurs, monthly stochastic studies will likely be in an oversold condition. If that proves to be the case, the decline in precious metal prices may end for the intermediate-term.

Nevertheless, a decline to the 138 area would represent an additional erosion of nearly 10% from Friday’s 153.42 close in the XAU. In addition, it would represent roughly a 30% decline from January’s 164.10 peak.

In any event, such a scenario would favor the expectation for a further rise in the value of the greenback as well as additional declines in both the S&P 500 Index and the Dow Jones Industrial Average.

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By Jim Donnelly, Olson Global Markets

Although the S&P 500 Index broke slightly above key trend line resistance at 1,130 and the Dow Jones Industrial Average nudged a bit above key resistance at 10,660, neither index was capable of stoking up buyer momentum and extending much higher. On the contrary, shifting political winds and the recognition that the rally since March needed to take a breather resulted in a “sell into strength” approach instead. Although the BKX financial ETF continues to form what appears to be a bullish reverse Head & Shoulders pattern and with the Dow Jones Utility Index backing modestly away, but not far from key trend line resistance at 408, it might well be the DXY dollar index that more accurately frames the change in investor sentiment that currently has both commodity and equities prices turning lower.

No doubt, the political landscape changed quite a bit last week. A stunning senatorial upset in Massachusetts became a glaring piece of evidence that health care reform may be forced to take a different direction. Another unexpected development was the realization that the reconfirmation of Fed Chairman Ben Bernanke may be in jeopardy. Additionally, the rolls of Treasury Secretary Tim Geithner and the Director of the White House’s National Economic Council Larry Summers have become cloudy. Further, big banks have become politically targeted with the announcement of the “Volcker Plan” which is designed to restrict the size and activities of the largest U.S. financial institutions.

Internationally, Chinese banking authorities have instructed some of their major banks to halt lending activity during the rest of January after a burst of credit expansion occurred in the first couple of weeks on the New Year.

What has all of the done? At the very least, it has induced money flows into the U.S. dollar as well as into U.S. Government bonds which was evidenced by the U.S. Dollar Index (DXY) spiking higher and breaking above another form of trend line resistance at the 77.90 level. With many technical indicators on weekly charts positioned bullishly, the likelihood for further dollar strength appears assured. A modest Fibonacci 38% retracement targets a move up to the 80 level on the DXY. A 50% correction sits at 81.80. A more likely outcome, however, might be a 61.8% retracement up to the 83.70 area. Not only does that level represent a Fibonacci number as well, it would also fit the character of the “C” leg portion of a corrective A-B-C “zig-zag” pattern.

If this scenario plays out however, it will likely keep both commodity and equity prices on the defensive for a while longer.

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Utility prices are sometimes seen collectively as a barometer of the direction of interest rates since utility companies are big borrowers of debt. If interest rates decline, their costs decline which becomes a big plus for utility stock prices. As a result of this relationship, utility prices are often seen as a leading indicator of equity prices in general.

With that in mind, it is worth noting that the Dow Jones Utility Index (DJU) has seemingly found key resistance at the 408.50 level (where key “cross” trend line sits) after having rallied from the 288.66 March 2008 low. With overbought technical readings on weekly charts now present, and with growing expectations of a rise in interest rates finding some traction, such a stall in the DJU Index is understandable.

A downturn in utility stock prices, if it occurs, would likely mute the bullish tone for both the Dow Jones Industrial index and the S&P 500 Index if the 408.50 continues to hold as key resistance. On the other hand, a solid break above 408.50, if it occurs, would be very positive for equity prices, particularly if the financial sector follows through to the upside. It would also suggest that recent expectations for a rise in interest rates may be misplaced.
For the time being, however, bullish sentiments for equity prices will likely be put on hold until a solid break above the 408.50 resistance area on the DJU index occurs.

Jim Donnelly, Olson Global Markets

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By Jim Donnelly, Olson Global Markets

As we observed early in December, a bullish reverse Head & Shoulders pattern appears to be developing on the Keefe, Bruyette & Woods U.S. Bank Index (BKX). At this point in time, it is getting ever closer to a test, and potential break above key “neckline” resistance at the 48.50 level. If a “breakout” does occur, it is important to note that the “objective” of this pattern is for a solid rally up toward the 79.50 area, which is a nearly 70% jump from Friday’s close of 47.

Such a move, if it occurs, would have a powerful impact on the direction of the S&P 500 Index and the Dow Jones Industrial Average; as well as improving market psychology and most likely credit conditions all at the same time. It would also suggest that while the yield curve could steepen, which would greatly help potential bank earnings, underlying asset conditions could be finding their footing.

Much consternation has developed over the actual market value the assets that the Federal Reverse has purchased from banks. Investors are equally troubled by the size and scope of the risk that Fannie Mae, Freddie Mac and FHA have on their respective balance sheets. Nevertheless, a solid rally in the BKX from current levels would have bullish implications for the banking system and overall economy, which would be welcomed by both Wall Street and Main Street alike.

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By Jim Donnelly, Olson Global Markets

Although the S&P 500 Index (SPX) temporarily broke above key trend line resistance drawn off the all-time high that last week came in at 1,120 (in red), it has yet to break above important “cross” trend line resistance (in blue) that now sits at 1,130. With overbought conditions now present on weekly charts, that becomes an issue for the current bullish trend.

Helping to explain the way equity prices ended the year were: position squaring maneuvers by professional traders early in December; increasingly better weekly jobless statistics; expectations for better earnings in 2010; and a decline in market volatility. A relatively narrow trading range over the past few weeks of December was also influenced by political unrest in Iran, renewed worries over terrorism, and colder-than-expected weather in the U.S. The resulting firmness in the energy sector helped both commodity and equity markets remain buoyant until the final trading day of the year.

Technically, the S&P 500 Index (SPX) needs to close above the 1,130 level in order to keep the bullish trend going. If it does, and if it happens on increased trading volume, much higher levels in equity prices could result. Weekly charts, interestingly, point to the possibility of a move up to the 1,400 area (in green) at some point over the intermediate term.

Nevertheless, a failure to extend higher soon (particularly with overbought conditions now present) could trigger a bearish corrective phase where a possible move down to the 960 area might unfold. The 960 level represents both 50-week moving average support as well as the “neckline” of a former bullish reverse Head & Shoulders pattern on intermediate-term charts. A marked increase in volatility should accompany such a correction.

In any event, a resolve to the direction of price will likely occur over the next few weeks as investors re-establish positions for the new trading year.

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