Price action that comes after a major announcement reveals a lot about underlying economic trends and the psychology of the market. Leading up to the election investors became enthusiastic on precious metals and commodities as QE2 was celebrated. Then the official announcement of QE2 caused the precious metals to gap higher as euphoria of the Fed's move were celebrated. As the celebration continued for gold bugs, as hard as it was, I believed was time to fight the investment herd and take profits. I warned readers that a healthy correction could begin and do not buy the recent breakout. Key high volume reversal days and negative divergences indicated there could be 15-20% correction and a countertrend rally in the dollar.
Concerns of sovereign debt issues are now returning as borrowing costs rise in Europe and U.S. Bond yields have moved higher over the past 5 weeks. Economic conditions are worsening in Europe and emerging markets in reaction to quantitative easing. Concerns of sovereign debt issues are weighing on the Euro, supporting a move into the U.S. dollar. Borrowing costs to insure government debt are reaching record levels. Ireland, Greece, Spain and Portugal are in danger of defaulting.
Rising fear of China slowing down through raising interest rates is putting significant pressure on precious metals and mining stocks. Commodities have significantly moved higher over the past 3 months and emerging markets have helped the equity market march to new highs. The global reaction to QE2 may continue to put pressure on commodities and precious metals as the carry trade of dollars into precious metals is reversed.
This move by China is causing a significant correction in precious metals, which I warned readers in my last article. China is responding to the devaluation of the world's reserve currency by attempting to slow down the world's fastest growing economy. Fallout in Europe and emerging markets may be short term bullish for the dollar and give long term precious metals investors a better opportunity to enter the market.
The dollar has reached one month highs as investors are fleeing the Euro into the dollar as European debt issues weigh. Notice the negative divergence between the RSI and MACD signaling the QE2 announcement to be a potential intermediate low. I am watching if the dollar can break its upper resistance line and 50 day moving average to the upside. I believe deteriorating financial conditions in Europe could continue the move into the dollar from the Euro. Emerging markets attempting to prevent imported inflation could put pressure on commodities including gold and silver.
High volume sell offs and reversal have signaled time to take less risk and wait for a pull back. A high volume break of the rising support line could cause a fast and furious decline as it would be a classic rising wedge reversal pattern.
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