Missed last rally? Buy Now!

Missed last rally? Buy Now!

In the previous week, Nifty crashed as we were expecting it to. (See Approaching resistance, 31^st May). Was this a correction or reversal?

We get the answer from looking at weekly charts. Nifty has taken support at the rising trend line. The index managed to close above 50% retracement of 6357 to 2252 at 4317. In the process, it formed a hammer showing the buying interest that is coming at these levels. It it interesting to note that every price decline in this correction was at decreased volume and every price rise was on increased activity. This gives us an important clue that current fall was a correction and not a reversal.

Having said that, we must remember that almost every technical indicator is in overbought zone. Even in this fall, stochastic failed to return to oversold condition. So a much deeper correction maybe in hold in future. Currently, An oversold stochastic would have been almost an perfect buying opportunity as directional index shows that bulls are in complete control of markets.

However there is no certainty in this world and, despite overbought indications, I favor a bullish view on basis of volume analysis. Nifty should easily run through resistance at 4690- 4850 in this rally. I would expect it to test 5300-5500 zone in few sessions. It is strongly advisable to go long with a stop loss below 4100 for a target of 5300.

Only risk I can see is current analysis is possibility of a head and shoulder reversal pattern in daily charts. During the correction volumes have rejected lower prices. We would watch closely for any decrease in volumes during up move which will alert of a possible reversal. In case of decreased activity we will liquidate our long near left shoulder high of 4500 and wait for breach of this level to enter long again. If the prices start declining on increased activity from there, we will wait for break below 4100 to initiate shorts. However, as long as volumes confirm with prices we will continue with our long position as per previous para.

Interestingly, USD faces enormous resistance against rupee. It has hit previous gap and both trend line as well as Fibonacci resistances at these levels call for a weaker Dollar. (Tip for NRIs: if intend to send some dollar home, it might be the right time.) One interesting development we saw on Friday was an US based funds selling USD in large amounts. So, are we looking at more FII inflows ? Lets wait and watch.

What is hurting US dollar

What is hurting US dollar

Recently, US dollar has been in a free fall against a basket of of other major currencies. This has left many investors wondering what exactly is hurting the dollar.

A number of reasons seem to be leading to a depreciating dollar. The most obvious of the reasons is the perception of a stabilizing global economy. A stronger economy leads investors to return to stocks and other riskier securities. This leads to what is called “carry trade” and erodes US dollar strength as a “safe haven”. In layman's terms it means that investors need to sell their dollar denominated government holdings and convert it into various currencies for investing. This leads to selling of the dollar against other currencies. This leads to a fall in Dollar value and the present scenario appears to be related to this phenomenon. This may be considered a short term cause of a falling dollar and may be viewed as a positive development as the underlying cause is an improvement in the global economic scenario.

However, the medium term reasons seems to be negative. The medium term reason that seem to be dampening the dollar is related to the US fiscal deficit. The damages caused by the economic depression are enormous in the shape of bust banks, bad home mortgages, looming unemployment and closing businesses. To repair these damages the US government has announced a number of bailout packages. The money for these bailout packages can come from two sources. The government can either print more money (currency notes) or borrow money. The first recourse is highly dangerous which will lead to very high inflation. The wiser thing is to borrow money. However, the borrowing money has a cost. A high level of government borrowing leads to a general rise in the interest rates unintended results like crowding out of private investment. In simple terms, when government starts borrowing interest rates rise making it wither difficult or unprofitable for private firms to borrow and invest in new business or in expansion of existing business. It may be noted that this increase in the interest rate is not induced intentionally to fight inflation, but is a result of worsening economic conditions. This presents a negative view of the US economy, which is likely to keep the dollar subdued in medium term.

What is presented above is theoretical discussion of two primary issues leading to a weak Dollar. In actual practice what happens is that investors who see weakness in US dollar start selling it and converting to other currencies. This can be done, for example by selling USD against CHF or buying EUR against USD. On of the biggest worries have been concerns that Chinese investments in US dollar may be liquidated. The reason why China is feeling the heat is because it holds a huge amount of national saving in US government treasuries and a fall in the value of the US dollar means a fall in the value of their national savings. China has become the largest holder of US paper, with investments of nearly $768 billion. The dollar index has weakened nearly 8.6% since February this year, making the Chinese jittery about their savings. This threatens liquidating of Chinese investments and conversion into other currencies.

How things actually unfold remains to be seen. Obama has already made tall promises of curtailing the deficit to 3% of GDP. However, Obama’s plan needs to be analyzed more closely before one can jump to any conclusion. Fiscal deficit is not something which can be wished away overnight. To reduce fiscal deficit ether government expenses need to be reduced by curtailing expenses or government revenues need to be increased by increasing taxes. Reducing government expenses in such economic scenario seems impractical where more chaos is likely if government stops bailouts. Only way to increases government revenue is by increasing taxes. However, an increase in taxes reduces disposable incomes of consumers. Lower disposable incomes can slacken demand and reduce production. This in turn can again slacken growth of GDP, leading to a negative investor sentiment, which can exert further downward pressure on the value of the US dollar.

In conclusion, fundamentals dictate that the US dollar may face some downward pressure in the medium term and its long term performance will depend upon how the US economy recovers during this period. In any case, we can be happy to note that the most of the talk today is about economic recovery and the recession seems to be fading into the past.