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Is Plunging Euro Bullish or Bearish News for Gold?

This essay is based on the Premium Update posted on April 23rd, 2010

In our previous essay we've discussed i.a. the changes in the strenght of influence that the U.S. Dollar has on the price of gold and what it means to gold Investors / Traders. In the following essay, we will provide you with a follow-up on the analysis regarding U.S. Dollar, and then we will move to the gold market itself.

In the first part of this essay we will begin with a reply to the interesting question that we've received during the previous week about gold, U.S. Dollar and Euro. The question was:

Since Greece looks likely to default ... Are we now looking at a major drop in the value of the Euro resulting in a major rise in the value of the dollar ... resulting in a collapse of gold prices?

In addition to the points made in the full version of this essay, we would like to provide you with additional thoughts regarding that matter, as there is another reason as to why the Euro down -> Dollar up -> Gold down is not that simple.

The market mechanisms would work in the above-described way if we assumed that the value of gold in Euro couldn't change. In this case if value of Dollar increased against the Euro it would have to mean that its value against gold would also increase. In other words, value of gold in USD terms would indeed decrease.

However, not only can the value of gold in Euro change, but it (as you will see on the gold:UDN ratio chart, which trades very closely do the gold in Euro) has very strong technical reasons to rally.

Now, if we assumed that the value of gold in Euro moves much higher ceteris paribus (all other things unchanged), then the above implication (Euro down -> Dollar up -> Gold down) loses its reliability.

Let's take a look at a simple simulation:

  • Gold in Euro moves up by 100% from 1,000 to 2,000
  • Dollar goes up against Euro from 0.7 to 0.9 (meaning that 1 dollar used to buy 0.7 Euro and now it buys 0.9 Euro)

What impact does it have on gold in the U.S. Dollar?

At the beginning gold traded at $1,429 (1000 / 0.7) and now it trades at $2,222 (2000 / 0.9), which means that it increased by about 56%.

So - we have an increase in the value of gold in both: USD and EUR, which means that gold increased its value against the U.S. Dollar while the Euro decreased its value against the U.S. Dollar.

Of course, the numbers above are just hypothetical, and everything depends on the sizes of the respective rallies/declines, but the above example clearly shows that a decrease in the value of Euro (against the Dollar) does not need to translate into lower price of gold.

At this moment, it's not hard to imagine European investors to purchase gold in response to the Greece-related turmoil. Yes, there will be investors willing to purchase dollars as a safe-haven (which we find rather ironic at this moment), but some may be willing to purchase PMs. As in many other cases - charts provide timing details, and right now, the situation appears bullish - also from the non-USD perspective - we will get back to this issue in the following part of this essay.

Moving on to the analysis of charts, let's begin with gold from the long-term perspective (charts courtesy by http://stockcharts.com.)

SPDR Gold Trust Shares

The big news is that we have seen the return of a self-similar pattern meaning that past performance would likely be replicated to a considerable extent. During the previous week, we saw a continuation of this trend. In the latest Market Alert, we suggested buying gold, silver and mining stocks even though a period of sideways movement may be imminent. We did have some sideways movement this week, as indicated at that time and with the RSI moving down from around 70 to 50 it seems that gold is becoming ready to rally soon (as explained in the full version of this essay - not necessarily immediately.)

The 50-day moving average also comes into play here. Please note that at the end of September 2009 gold bottomed after declining about half of the distance between previous high and the 50-day moving average. This is also where we are today, which suggests that gold is not likely to move below the very recent low - or even if it does - that it would move much lower.

The Stochastic Indicator suggests that it should be below the 20 level before the true bottom is reached. Presently it is around 50. This indicates that we may need to see further consolidation with gold trading sideways in a tight trading range

History tends to rhyme more often than repeat and therefore we do not advise waiting for the Stochastic Indicator to drop to 20. It may, for instance, only go down to 30 or even 40 before the consolidation completes and the rapid rise begins.

The analysis of gold from the non-USD perspective confirms points made above.

Gold:EDN

From the non-USD perspective, let's revisit the April 9th, 2010 Premium Update explaining exactly what the above chart indicates:

UDN is the symbol for PowerShares DB US Dollar Index Bearish Fund, which moves in the exact opposite direction to the USD Index. Since the USD Index is a weighted average of dollar's currency exchange rates with world's most important currencies, the gold: UDN ratio means the value of gold priced in "other currencies".

On April 9th, 2010 we wrote that we can expect a brief test of this breakout.

This is precisely what we've seen - the ratio declined to the 42-43 area and moved back up, thus confirming the breakout. While it is not certain that this ratio will move higher immediately, this chart clearly indicates bullish trends for the medium- and long term. In the short term some consolidation is not out of the question, but we don't think that a plunge below the 42 level is likely, which is in tune with what used to happen at the end of April.

Summing up, last week we stated that we expected gold to move sideways or decline slightly in the near-term, but we were bullish medium-term, consistent with the prior week and these comments are up-to-date also this week. The full (6 times bigger) version of this analysis is available to our Subscribers.

To make sure that you are notified once the new features are implemented, and get immediate access to my free thoughts on the market, including information not available publicly, I urge you to sign up for my free e-mail list. Sign up today and you'll also get free, 7-day access to the Premium Sections on my website, including valuable tools and charts dedicated to serious PM Investors and Speculators. It's free and you may unsubscribe at any time.

Thank you for reading. Have a great and profitable week!

 

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