Should You Chase the U.S. Dollar’s Rally?

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The U.S. Dollar (NYSEARCA:UUP) has been rallying since early May, and is 6% higher since.  This is a really big move in such a short time for the world’s largest currency.

Even though the implications of such a move are astronomical, it has still taken the Wall Street Journal until this weekend to put it on its coveted front page where the cover headline reads, “Resurgent Dollar Fuels Rally”.

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One of the main points of the article is how the dollar just broke a 17 year record by rising for nine weeks in a row.  But, why did the WSJ just now catch on to the rally that has been going on for five months?

Contrarian Investing

For the typical investor, putting the Dollar on its cover and talking about how its improvement is driven by better U.S. economics may seem like a reason to buy.

But to the smarter investor aware of sentiment and contrarian signals (such as our subscribers), this is a major reason to expect at least a short term relief pullback or stall in the Dollar’s rally (and Euro’s decline).

WATCH: Why the Euro has Made a Major Top

The Dollar is now displaying the age old “cover of the magazine” characteristics as the public is now fully aware of the trend, likely the last to know, and likely now buying into it at exactly the wrong time (after an already strong 6% gain).

Readers of our Profit Strategy Newsletter should recognize the chart below, which I included back in February (chart now updated through today) in a research piece entitled, “Do Dollar Bears Have it Right?” when the trade weighted Dollar was trading for $80 (it’s now up over 5% to $84.24).  We were fully prepared for this rally in the Dollar and decline in the Euro.

Back then, the mainstream media was very bearish and suggesting an imminent demise in the Greenback, even though the Dollar has actually been in a rising trend since its lows back in 2008.

Remember these actual headlines from February and March when gold (NYSEARCA:DUST) was trading near $1400 and the Euro (NYSEARCA:FXE) was near $1.40?

“Gold and Silver Fever Returns” – Feb 14 – WSJ

“Europe’s Economic Revival Continues” – Mar 3 – WSJ

Or, how about this quote from a commercial that was prevalent on one popular news outlet earlier this year, “With the Fed printing Billions of Dollars each year, you need to protect your purchasing power”?

And what happened since?  The Dollar kicked off the rally that continues through today while the Euro and precious metals have tanked.

The opposite sentiment scenario is playing out now, though, as the Wall Street Journal article shows the media has after six months of gains, finally jumped on board the stronger Dollar theme.

That is reason enough for contrarian investors to take notice, but there is even more to this story.

Technicals and Sentiment Support a Short Term Pullback

Back in February it was pretty clear from the charts that the $79 level on the Dollar was a key “line in the sand” as we discussed back then in our newsletter.  That level was never breached.

Bears were also warned, “A breakout of that pattern (shown in the chart above) would cause 10 years worth of bears to realize they are on the wrong side of the trade, eventually joining the bulls in buying back their shorts.”

We are certainly starting to see that now as the WSJ pointed out, “nine weeks in a row of gains” as the Dollar breaks out of its 10 year basing pattern.

I reiterated that stance in a research piece I wrote dated April 3, “Is the Euro About to Tank” that can be found on our homepage.

Back in February, real money speculative bets on the Euro (traditionally considered the dumb money) were also back at similar elevated levels that coincided with a previous major top in the Euro (NYSEARCA:EUFX), 2011′s price highs at $1.45.

Check out the chart below that points out these extremes.

Sentiment extremes as measured by speculative positions typically coincide with major turning points.

In March 2014, after a year and a half rally, speculators were extremely long the Euro again, just as they were in 2011 at a similar previous major peak in price.

In an opposite extreme, our latest Technical Forecast (issued 9/14) showed that speculators have also jumped on the recent Euro selloff, now as short as they were during previous Euro bottoms.

This combined with the technically overbought readings and the Wall Street Journal cover article suggest the Euro’s decline should at least stall soon.

With the Scottish Independence vote and FOMC minutes later this week, I expect the Euro to rally as a result of the technical and sentiment condition (no matter what the outcome of the vote is).

However, this rally is expected to be just a relief move, likely offering another great opportunity to get long the Dollar (NYSEARCA:UUPT) and short the Euro (NYSEARCA:DRR) once the counter-trend move completes.

The ETF Profit Strategy Newsletter covers all the world’s major markets to keep our subscribers ahead of the major market movements.  It is likely the U.S. Dollar has just started a long term advance. But given the extremes now reached as measured by the technicals/sentiment along with the fundamentals (Scottish vote and FOMC minutes due out this week) it is likely a pullback will first interrupt the Dollar’s advance.