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Equity bounce depends on dollar fall, copper revival PDF Print E-mail
Written by George Albert   

Written for First Post
June 9, 2012: The dollar rally paused this week as prices hit a previous sell off point reducing the appetite for safe havens, which led to a rally in the equity markets. Unless the Dollar sells off a continuation of the equity rally is in doubt.

Additionally the leading indicator of the equity markets--copper--is not showing signs of strength. Copper the barometer of economic strength usually rallies before the equity markets. Even though the Sensex in India and the Dow in the US rallied strongly this week, copper did not, casting doubt on the strength of the bulls. 

The market this week threw many traders off balance. After a sell off last week many bears anticipated a further fall this week. That however did not happen as the market rallied. A majority of analysts attributed the rally in the early part of the week to the expected stimulus from central banks, which could possibly be the reason. But one never knows for sure why the millions of traders buy or sell on any given day.

For instance when European Central Bank did not ease money, the European markets fell. But so did the China markets despite cutting rates. The US markets on the other hand rallied at the end of the week despite the Federal Reserve chairman not making any statements about more quantitative easing in his testimony before the congress.

Readers of this column however would have anticipated the pause in the equity sell off for three reasons which are the dollar hitting resistance, the Sensex not breaking support and lack of strength in copper prices. We have spoken about inverse relationship between the Dollar and equities. A look at the dollar index chart (click here Dollar index chart ) shows that prices hit resistance last week. We had marked these resistance levels in previous articles. Prices often turn lower from resistance, which increased the possibility of an equity rally given the inverse dollar-equity relationship. Dollar is a safe haven and equities are considered a risk play. Hence when the appetite for risk increased the the value of safe havens fall. 

Along with the Dollar index hitting resistance the Sensex and even the US equity markets hits support. We had mentioned in previous articles that unless the Sensex closed below its gap support level the market would not go lower. Prices often turn higher from support levels as the demand for stocks exceeds supply. In the final analysis demand and supply always determine price levels. A look at the Sensex chart (Click here Sensex chart ) shows that the index rallied from the gap support level shown by the green lines. 

Finally a look at the prices of copper (Click here for Copper chart )shows that even though the equity markets rallied copper refused to follow.  Copper often leads the equity markets up.  Copper is considered a leading indicator of the equity market as the metal shows the health of the economy. The relationship between copper, the equity market and economy has worked many times

Copper is used in most manufacturing processes and a fall in copper prices show a drop in demand for the metal. This shows that manufacturers don't need the metal as they foresee a slow down in their business. As manufacturers slow down so does the economy. Since the stock markets discount the future, they tend to fall a little after copper prices fall and vise versa in a bullish scenario.

In fact in December 2008 copper stopped falling and began to rally. However, the equity markets began to rally only a few months later in March 2009. Again in February 2011 copper had began falling, but S&P 500 continued to rally and fell strongly a few months later.

Looking ahead

So will the Sensex continue to rally. Like we said last week a cut in interest rates by the Reserve Bank may do the trick. However, the charts show many hurdles for the bulls. First copper is not showing strength. Second the Sensex faces a few resistance levels higher up which is shown by the red lines on the chart. Also note that death cross almost happened this week and prices are near the crossing level. For more on the death cross please read last week's article. 

Finally one has see if the appetite for risk is back on the table and that will be shown by the dollar index.  The dollar index is now trapped in a narrow zone of a support level at 81.82 and a resistance level at 83.56. Unless the index closes below 81.82 a further rally in equities seems difficult. And even below 81.82, there is another support level of 81. These levels have to be cleared for a sustain rally in equities. 

On the other hand if the dollar index rallies above 83.56 it will bad news for equities.