US Dollar and Oil Hold Clues About the Future

The past few months have been a difficult environment for anyone that was bearish. The next few months may prove to be difficult for everyone regardless of directional bias.

We live in a world where headlines can move the market in split seconds as high-frequency trading robots cause flash rally’s and flash crashes regularly.

As an example, the price action in the Market Vectors Short Muni Index (SMB) on February 28 demonstrates the impact that these high frequency traders have on illiquid underlying assets.

I certainly hope there were not any absent-minded retail investors that got caught using market orders during the flash rally only to recognize losses as great as 5% or more in a matter of minutes.

The following chart illustrates a flash rally and the monster 40% plus rally witnessed in less than one minute. Can someone say fat-finger mistake?

Market Vectors Short Muni Index One-Minute Chart



In addition to high-frequency trading, I have to constantly monitor the headlines coming out of Europe as one event or official statement has the potential to cause the euro to rally or selloff almost instantly whether the information is fact or fiction.

My firm and I have traded small for the most part during the beginning of 2012 as market conditions have been volatile even if the Volatility Index (^VIX) has not necessarily supported that view.

One after another, perma-bears have capitulated to the bullish camp, and now we have pundits calling for the Dow Jones Industrial Average (^DJI) to move over 15,000 by the end of the year.

We use strategies that in many cases would be considered contrarian by nature. Admittedly we will not get every move in the market correct, but what we will do is layout key areas that price action should migrate to in the form of key price levels across short, intermediate, and long-term time frames.

My firm's objective is to provide readers and our members with actionable information that can be viewed objectively by both bulls and bears alike. With that said, the following viewpoint we have of the marketplace today runs contrary to the collective group of market pundits.

While most market pundits expect higher prices and stronger economic data, there is reason to believe that recent developments could be indicating that volatility may lurk ahead. Volatility could rise up and push equity valuations lower in the near term.

The daily chart of the iPath S&P 500 VIX Short-Term Futures ETF (VXX) shown below illustrates that the VXX has seen strong volume in the past few weeks. Additionally the VXX appears to be trying to form a bottom.

With volatility at these levels, put protection is cheap and it would appear based on volume that the smart money is getting long volatility. Long VXX trades are designed to either act as a portfolio hedge or as a potential profit mechanism should a correction play out.

Ipath S&P 500 VIX Short-Term Futures Daily Chart



By now most readers are aware of the rally that has been taking place in oil futures for the past few weeks. Nancy Pelosi came out with a statement blaming those evil speculators again while Republican presidential hopefuls used higher oil prices as another key political topic against the current administration.

Just when the noise was starting to rise to a roar, the marketplace was quieted by a rally in the US dollar on February 29. The daily chart of the Dollar Index futures is shown below.

Dollar Index Futures Daily Chart



Do readers find it rather odd that just about the time when oil was on the lips of every media personality in the United States that the Federal Reserve issues a reverse-repo to pull in liquidity? Do you find it at all coincidental, or could it be that Federal Reserve Chairman Ben Bernanke was told to slow down the rally in oil prices?

After the reverse-repo was performed, the dollar soared higher and was showing continuation to the upside on Friday afternoon during intraday trade. The dollar is potentially forming a bottom presently, and the fact that the Federal Reserve is aiding in that formation presents additional risk for downside in the S&P 500 Index and precious metals in the near term.