I first touched on this topic last week:

“So that’s what I’m working with. All three asset classes look overbought to me: bonds, gold and the Euro/CHF, and I suspect that their rallies are related and associated in traders’ minds with recent Fed and Treasury actions.”

Today the dollar is rallying strongly against other currencies and gold, which behaves like a volatile currency, and Treasuries are falling sharply. This is a reversal of December’s big moves. The dollar fell as the bond climbed. The two are maintaining a kind of balance — from a foreigner’s perspective, you don’t want to buy Treasuries with high bond prices and a high dollar, since that exposes you to elevated currency risk as well as price risk. As bonds correct their overbought condition, the dollar can rise.

This is just my 2 cents on the last few weeks — bonds and the dollar were strong together in the crash, and they can be again. It was only when bonds ran away in December that the dollar corrected sharply.

Is this the start of the next leg up in the dollar, which could push the Swiss Franc down under 80 cents, the Euro to under $1.15, and gold to near $600? Maybe, but it would be odd to see the dollar exhibit that kind of strength without further deleveraging in ‘risk’ assets like equities, corporate bonds, energy and base metals. So, the question is, should we expect such weakness in equities et al. or should we expect a short-lived dollar rally?

The strongest indicator we’ve had in the markets of late is that Treasuries were overbought by late December. This is not to say that we won’t see 2.5% yields on the 30-year again, but simply that this run was overdone. If Treasuries continue to fall, that would typically coincide with more animal spirits in the sectors that got clobbered this fall, in which case the dollar may find its rally short-lived at best, since dollar weakness was such a part of the bullish atmosphere from ’04 to early ’08.

The “short Treasuries” crowd is very much of the inflationist bent, so I would not be surprised to see oil and base metals surge with a continued sell-off in bonds, but then gold and gold stocks have already been overbought (I bought GDX and GLD puts last week), so we have a major divergence among the so-called hard assets.

This is not an easy market to read, as is characteristic of Elliott wave 4. It is best to just stand aside until things are more clear.

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PS — Just sold my TBT for a quick 8%, as well as those January DIA puts that I bought at Friday’s close. The Treasury short is a crowded trade, which I don’t like, and the strenuously overbought condition is now releaved. Bonds could fall a lot more here, but with a short ETF, any chop in the trading can eat up your returns.