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Is the Seesaw About to Tilt With the Dollar Up, Gold Down?

This essay is based on the Premium Update posted on October 8th, 2010

The lines are drawn, the cannons are loaded - the currency war has begun. The opening shots have already been fired with the biggest battles still ahead. This is a superpower currency shoot-out with other counties trying to avoid getting caught in the cross-fire. Each nation is taking unilateral actions to defend its economy from the other in an escalating battle over the value of the world's key currencies.

This is good for the price of gold. Gold jumped to fresh dollar records above $1,350 an ounce early Wednesday, hitting its 16th new all-time high in 17 trading days.

A growing number of countries see a weaker exchange rate as a way to lift their economies. They want to export their way out of trouble. This war is over the ability to export to other nations and about keeping your own citizens employed during a period of an extended slowdown in global demand. Nations will either vault forward or fall behind, so they are trying to protect their own turf, a worrying signal that all is not well with the global economy. Countries tend to be less bothered about a strong currency in good times.

With further quantitative easing in the developed world, the appeal of hard, unprintable currencies like gold and other commodities will continue to shine. Given the budgetary jam U.S. leaders find themselves facing, they understand that one of the few options they have is to boost American exports by devaluing the dollar.

All this in the long term will be very good for gold.

The magnitude of recent upswings and downswings has been amazing when reviewed over a two to six month period. For example, the Euro Index rose over 6% since August 1st, while the USD Index declined more than 5% during the same period. Gold rose nearly 14%, silver 20% and stocks less than 0.5% during the same time period. 'Slow and steady' seemed to be an obsolete term when looking at recent market moves.

The multiple turning points which are at hand or imminent in many world markets are further evidence of the dependencies and interrelationships, which have formed in what at first may seem unrelated areas. It is quite true that when the Bank of Spain has a liquidity problem, the price of silver could very well be impacted immediately. Such is the case when the all global economies are so interconnected. We saw such an example, albeit temporary, this week when Japan devalued the yen on Tuesday. World markets immediately reacted.

Speaking of currencies, the very long-term USD Index chart (charts courtesy by http://stockcharts.com), which shows trends from a weekly perspective, is clearly approaching an important support level today. Although we may temporarily see a move slightly below this level, the local bottom is likely very close to being in.

US Dollar Index - 3-Year Chart

With strongly negative correlation between metals and the USD Index, the implications for precious metals are bearish. The local top should be quite close although double-tops cannot be ruled out and should therefore not be surprising. It all depends on whether the support level has enough strength to stop the USD decline at 77, or will it need to move lower to 76. We believe the former is more likely.

US Dollar Index 18-Month Chart

In last week's Premium Update we stated told our Subscribers that the target level for the current decline is close to 77 and that a pullback/consolidation is probable once this level has been reached. If the bottom is in fact in, (and it certainly appears so), it means that the index is following our expectations remarkably well. We expect the USD Index to rally in the following days/weeks.

The above would be bearish for gold. Speaking of the yellow metal, let's take a look at the very-long-term chart.

Gold

In the very long-term chart this week, we see that gold moved up to the upper border of the very long-term trading channel. Last week's stated target level was breached only temporarily. Although at fist sight, Friday's intra-day action might give a different impression, it seems as though gold's fervent rally may have cooled.

Thursday's decline from intra-day highs is an indication that the corrective phase may have begun, mainly because of the size of the decline and the fact that it was accompanied by huge volume The obvious question now is how low will gold's price go? We give our Subscribers specific numbers, but generally, specific targets fall in the $1,235 to $1,300 range. The good news is we have the strategy to determine which target will hold this downturn.

In recent weeks, gold's price rise has been very much USD driven. As we discussed earlier, once the USD Index reaches a local bottom, likely in the 77-level range, gold prices will probably decline. This is precisely what we have seen in the last day or so and it will be important to monitor the correlation matrix when gold's price approaches the target levels defined above to see which market is best aligned with gold at the time. This will allow us to better anticipate the likely turnaround.

So, should you put a small part of your capital betting on lower gold prices in the short run? Generally yes, but we don't' think that using any other instrument than options (or similar) is a good idea right now. If we have a confirmation that this move is very likely, we will let our Subscribers know that it's a good idea to add to their positions.

We received a question this week about how to manage risk in the long run and still be able to increase our portfolio? We have said this many times in the past and it cannot be over-emphasized - limit the size of your speculative positions and use most of your capital for long-term gold and silver investments. And, it goes without saying, keep your bullion holdings at all times. This way, if all hell breaks loose - your bullion will protect you.

If the rally will be steady and without any corrections, your long-term holdings will make you rich. If the bull market will take two steps forward and one step back, as is mostly likely, you will be able to gain on most of your speculative trades and increase the value of your portfolio over time. Even if some trades don't play out as expected, it will not destroy your capital but only decrease its speculative part on a temporary basis.

Summing up, the Euro Index and the general stock market have likely reached their local tops and the USD Index - a local bottom. Even if it is not the case at this time, we are very close to turning points. This has wide bearish implications for stocks and precious metals, driven by recent rally to extremely overbought areas in short-term.

The magnitude of recent upswings and downswings has been rather amazing when reviewed over a two to six month period. For example, the Euro Index rose over 6% since August 1st while the USD Index declined more than 5% during the same period. Gold rose nearly 14%, silver 20% and stocks less than 0.5% during the same time period. Slow and steady seemed to be an obsolete term from the past when looking at recent market moves.

The multiple turning points which are at hand or imminent in many world markets are further evidence of the dependencies and interrelationships, which have formed in what at first may seem unrelated areas. It is quite true that when the Bank of Spain has a liquidity problem, the price of silver could very well be impacted immediately. Such is the case when the all global economies are so interconnected. We saw such an example, albeit temporary this week when Japan devalued the yen on Tuesday. World markets immediately reacted.

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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