Nobody wants to talk about inflation. It is hard to imagine that in this economy inflation could be a concern. Deflation is still the hot topic of the day amongst the economists. Gary Shilling is becoming extremely popular again with his book, Deflation: How to Survive and Thrive in the Coming Wave of Deflation. By the way, this is a great read for anybody studying the history of the markets. While the broader picture and past economic data might suggest that inflation is still a long ways off, the current market prices are suggesting a different story. Since the markets are forward looking indicators, I will take my cue from them.

But what markets should you be looking at? The first signs of inflation will always creep up in the capital markets, namely the Treasuries. This is due to the inverse relationship between bond prices and interest rates. If you remember your Economics 101 class, you will recall that rampant government spending, extreme monetary easing, and massive deficits all eventually lead to higher interest rates and higher rates of inflation in the long run. You can't continue to print money without eventually affecting the long-term interest rates. For anyone who trades the short term, or is a swing trader, the charts don't lie. Let's take a look at the charts on the TLT, or Barclay's 20-year bond.

Significant support has been taken out at the $100.00 level. While the volume is weak, a shift from the relative safety of bonds as an investment play to more speculative bullish equity plays is occurring. The recent 30% rally in the equity market has to be a testament to renewed investor confidence. Last week's consumer confidence report also pointed to a shift out of Treasuries and back into equities. The chart above suggests the next level of significant support for the TLT won't occur until about $93.00, so there is still room to fall.

In addition to the capital markets, we can take clues from the commodities markets for signs of creeping inflation. Commodity prices, as an input price, will traditionally act as a harbinger for forecasting inflationary pressures. Below I have included charts for some of the commodity ETF's that I follow on a regular basis. Included are MOO (agricultural products) and OIH (oil services).

The MOO chart is very telling of an upward bias. There is strong upward momentum demonstrated with the flag pattern pushing through the $31.00 level which had acted as resistance three times before. There is an increase in volume during this trend signifying this rally could have some legs to it.

OIH demonstrates a nearly identical bullish pattern with resistance being penetrated at the $89.00, albeit with less of a volume spike. The markets are speaking, and it is up to us to take notice. If you missed the first leg of the inflation trade, don't worry. With any pullbacks to our new support levels, there will be time to add more.

thinkorswim, Inc. and its registered employee, Joe Mazzola, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

The eagerly awaited results of the stress tests for banks has been slowly leaking out and apparently needing roughly 34 billion dollars is a boon for the stock price of Bank of America. The bank was one of the 19 being tested which will apparently require additional capital and this news sent its stock price initially lower and then higher by 15%. This action moved the entire financial sector higher and propelled the broader market to new 2009 highs in many names and averages. The question which continues to abound is "Does this rally still have legs?" The answer seems to be a resounding yes.

The mystery to many traders is what is fueling this rally? Many traders believe the catalyst is the legions of investors who suffered significant losses in 2008 and hit the sidelines to wait out the turmoil. Now we have seen a significant leap of over 25% from the March lows and many are afraid they are missing the opportunity to recoup some of those losses. What makes that evident is folks generally like to get in on any dips and every time we have seen one in the last couple months they have been short lived. The buyers have not exhausted their buying power and until they do we are unlikely to see any significant pullback. Quite frankly, it would make it a much healthier rally if it was not linear. A mild pullback may help in lengthening the duration and intensity of the rally and guard against the sudden washout of a portion of it. All told, it makes me continue to look for opportunities for short-term trading profits and remain very cautious with respect to long-term opportunities. I still expect a pullback and realize that the longer we go on rallying the more dramatic it will be, but I am not fighting the cash flows.

thinkorswim, Inc. and its registered employee, Steve Quirk, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.

Over the past few months, the U.S. dollar experienced a significant sell-off. The dollar index hit one-year lows and has seen the most significant loss against commodity-based currencies, such as the Great Britain pound (GBP), Australian dollar (AUD), New Zealand dollar (NZD) and Canadian dollar (CAD). Recovery from the global economic crisis has not arrived, at least according to the past month's economic reports. Even though economic recovery isn't apparent yet, inflation concerns are creeping into central banks' commentary and influencing monetary policy.

The U.S. has been the most active in intervention and stimulus during these economic times, which means it has pumped the largest dollar amount into the global market. As this money hits the global market, the dollar will weaken further and inflation will become more and more of a probability. The past two months' price action is a strong indication of the impending inflation. Historically gold receives the strongest boost in times of inflation and the Australian dollar is the major currency most correlated to gold. By buying Australian dollars and selling U.S. dollars, an investor simultaneously capitalizes on the aussie's strength and the greenback's weakness.

If you haven't noticed there has been a similar strand of logic and focus on inflation and commodities in the previous three articles. This is because central bank monetary policy and inflation are long-term trends and cycles, providing ample time to find and set up trade opportunities based on fundamental and economic principles. Instead of looking at the GBP/CHF, as was the focus last month, this month's focus is on gold and the Australian dollar. During the past quarter, the Australian dollar experienced a significant rise against the U.S. dollar, finding strong support levels near 61 and 63 before rising more than 1,500 pips to 78 (see Figure 1). There has been some expectation that the dollar has been oversold in the past couple of weeks. This works out well because a trend line support level and the 61.8% Fibonacci level may coincide on a pullback near 75, providing a better risk-controlled entry as a trend bounce. If the pair bounces at 75, followed by completing the 100% Fibonacci retracement to 84 and a stop was placed below the 50% Fibonacci trend line, a better than 3-to-1 reward-to-risk ratio would be established. The pair could run well past 84 to last year high at 98 if inflation remains an ongoing concern.

Figure 1 -- AUD/USD Rising with the Potential of a Pullback to Trend and Fibonacci Support

The AUD/JPY pair has a similar price pattern. As discussed in last month's article, the pair reached the 73 resistance line and a possible run higher has now appeared. As shown in Figure 2, price is at the 50% Fibonacci level. A break above the 61.8% Fibonacci level with a stop below the 50% Fibonacci level will provide the better than 3-to-1 reward-to-risk ratio with a target of nearly 1,200 pips. This pair needs to move more before confirming such a trend, which makes the AUD/USD, mentioned above, a more near-term probability.

Figure 2 -- AUD/JPY Testing Support at the 50% Fibonacci Level in a Strong Uptrend

The above examples can be traded using the forex spot market or combing futures properly via futures by buying Australian dollar futures (/6A) for the AUD/USD pair and Australian dollar futures (/6A) and selling yen futures (/6J) for the AUD/JPY pair.

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Trading spot currency contracts can involve high risk and the significant loss of any funds invested. Spot currency contracts are highly leveraged. This means that significant losses can be created quickly and unexpectedly.

Options trading is generally more complex than stock trading and may not be suitable for some investors. Granting options and some other options strategies can result in the loss of more than the original amount invested. Before trading options a person should review the document Characteristics and Risks of Standardized Options, available from your broker or any exchange on which options are traded.

I remember once, years ago, as I was walking out the door...I had been talking with my dad, and he said to me, "Anthony," (my dad never calls me Tony) and I stopped turned and he said, "Be careful." And I never forgot that. And it comes back to me often: Be careful. That was very good advice. The fear gauge, VIX as it is known to the market, is hovering at a critical level that could indicate increased investor confidence about the stock market. VIX, which recently has been at 29, is about the same level it was when the SPY was over 120 and the SPX was north of 1200. Presently, both are at 90 and 903, respectively. The financial sector, which includes banks, brokers, insurance, and real estate, is a place to be careful. From its March 2009 low to May 2009 high, the S&P Financial Spider (XLF) is up by over 100%. By comparison, the S&P 500 Spider (SPY) is up approximately 35% during the same period. Most US banks- Goldman Sachs, Morgan Stanley, Citigroup, Regions Financial Corp., Fifth Third Bank, to name a few- have in fact been able to raise billions of dollars in the past few weeks by selling shares after a broad-based financial rally. So who is buying all these new shares? I believe they are hedge funds that were caught short and now they are using these deals to cover their shorts. Also, it might be institutional money managers who feel like they missed the bottom and are now chasing these stocks! I'm not chasing! Not me, I am considering a risk reward trade favoring a directional downward bias in XLF.

Presently with XLF at $11.72 you may consider buying the June 13-11 Put spread for $1.12 debit and help finance that debit with the purchase of the June/July Calendar spread for $0.30 debit. It's profitable anywhere below $11.95 at June expiration. Max loss is $142.00, max gain at 11 is $118.00 with a little more then a 60% probability of success.

Some say that the government helped put a floor under the financial sector with all these bailout moves and allowing banks access to cheap money. Hindsight will ultimately decide this, but "be careful." That is very good advice.

thinkorswim, Inc. and its registered employee, Tony Battista, do not solicit or recommend any form of trading in the individual stocks (or their derivatives) mentioned above. Please do careful, independent research before investing any money as well as weigh the possible consequences on your particular financial situation before doing so. The risk of loss may be substantial.