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Gold and the Dollar - Current Market Situation

Here is an extract from commentary posted at www.speculative-investor.com on5th October 2003:

When discussing the Swiss Franc in our 29th September commentary we said "...a short-term peak is highly probable within the next several trading days. After that wed expect a 1-3 week pullback followed by a resumption of the rally." A surge in the SF during the first half of last week was followed by a sharp downward reversal late in the week, suggesting that a short-term peak is now in place and that the above-mentioned pullback is underway. Support at 0.72 (see weekly chart below) is a reasonable target for this pullback.

In last week's commentary we included daily charts of the Dollar Index and December gold futures showing roughly what was expected to happen over the next 1-2 months. Specifically, the Dollar Index was shown rebounding back to 94-95 from support at around the 92 level before resuming its decline while December gold was shown dropping to support at around the 370 level before resuming its ascent.

The only surprise so far is that the drop in the gold price to test support at 370 occurred over the space of 2 days rather than 2 weeks. This, in turn, probably means that the gold-market correction is going to be over a bit sooner than previously expected.

Below is a weekly chart of the gold price. Note that the weekly charts we show at TSI are always 'continuous', meaning that the price at any point on the chart is based on the nearest futures contract at that time. For example, October-2003 is currently the nearest futures contract so last week's 'candlestick' on the below chart reflects the action in the October contract. Similarly, during July-August the nearest futures contract was the August-2003 contract so the candlesticks in this timeframe reflect what happened to August gold. For this reason a daily chart of, say, December gold will typically show different support/resistance levels than a weekly 'continuous' chart.

Whereas the daily chart of December gold suggested a target of $370 for the current correction, the below weekly chart shows equivalent support at $365. Either way, gold is probably close to its correction low.

Although gold and the dollar have a strong inverse relationship, peaks/troughs in the gold price generally don't occur at the same time as troughs/peaks in the dollar. In fact, the extremes in the gold price and the corresponding opposite extremes in the US$ can sometimes be separated by several months. In most cases gold will lead the dollar, that is, a peak in the gold price will precede a bottom in the US$ and a bottom in the gold price will precede a peak in the US$, although this won't always be the case. There are no simple rules in the financial markets that work all the time. Rather, what we are always dealing with are probabilities. If we usually have the probabilities in our favour and we do a good job of managing risk then we will achieve well-above average returns over the long-term.

The only significant negative for the gold price that we know of at this time is that the silver price just completed a weekly close below important support (see weekly chart below). Markets will sometimes make 'head fake' moves below an obvious support level before embarking on a major advance and perhaps this is what silver is in the process of doing. However, we are not prepared to blindly assume that silver's recent plunge is just a head fake.

The weekly close below $4.90 by the silver price indicates that a peak for the year is probably already in place and therefore negates our upside target of $5.80. We don't see much downside risk in the silver price, but the break below support probably means that a multi-month consolidation is going to occur.

If the current correction in the gold market turns out to be longer and deeper than we currently expect then this would indicate to us that a major peak in the gold price (a peak that holds for 1-2 years) was most likely not going to occur until well into next year. We see little chance that the spike up to $395 during the week before last will turn out to be a major peak given the substantial downside in the US$ that we are confident will occur over the coming 6 months. In our view, a major peak in the gold price will only occur after the gold market has discounted a drop in the Dollar Index to around the 80 level.

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