It has been a heck of an
awesome week for gold, certainly one of the most exciting in recent memory. Not only is the Ancient Metal of Kings
closing in on the fabled $500 level in dollar terms, but the psychologically
crucial €400 euro-gold level was finally overcome. Gold investors everywhere, including
me, are rejoicing.
Contrarian investors and
even some mainstreamers are discussing gold’s sizable daily gains, but
I think the most intriguing aspect of gold’s action this week
surrounded its relationship with the US dollar. On Wednesday gold carved a new
bull-to-date high just under $478 while the US Dollar Index simultaneously hit a rally-to-date
high above 92. Such an event is
totally unprecedented in this gold bull, Twilight Zone stuff.
Born back in April 2001,
until June 2005 this gold bull’s behavior was heavily dependent on the
dollar’s fortunes. Like an
inverted mirror image of the mighty US dollar, gold rose when the dollar fell
and vice versa. Gold acted merely
as an alternative currency to the dollar and traded as such. Global investment demand was
insufficient then to drive gold high enough to decisively decouple from the
But back in June a
long-awaited event finally came to pass, euro gold broke above its long and
oppressive €350 resistance. This event was so important and
pivotal because it helped convince investors around the
world that this gold bull was more than just a dollar bear. New euro-gold highs helped signal that
gold finally had the fundamental strength to rise in all the important global currencies, not just in
the rapidly devaluing US dollar.
For years I’d been
waiting for the €350 breakout as it seemed like the most likely
catalyst to ignite Stage Two of this gold bull. Great gold bulls have three stages. The first stage is
currency-devaluation driven, gold typically only gains significantly as the
world’s reserve currency loses value. The second stage is driven by global
gold investment demand, forcing gold to decouple from the dominant currency
and rise on its own fundamental merits.
The dawn of Stage Two has
huge implications, it is when the gold bull really comes into its own and
starts galloping. Stage Two is a
paradise for investors since its ultimate gains ought to vastly exceed the excellent
gains with which we were blessed in Stage One. Since June’s €350
breakout, it looks like this gold bull is increasingly transitioning from
Stage One to Stage Two. I
documented gold’s dollar decoupling a couple months
This week to witness gold
actually close at its highest levels in this entire bull the very same day the rallying dollar achieved its highest level
this year is staggering! Gold is
being driven to new highs not by flight capital fleeing a crumbling dollar,
but by prudent investors around the world bidding up its price because they want to own gold. This is the clearest evidence yet of
gold’s dollar decoupling, of the glorious dawn of Stage Two!
In order to better
understand this phenomenally bullish event, I decided to update our Stage Two
charts this week. They use euro
gold as a proxy for documenting gold’s extra-dollar progress, compare
rolling-month returns of gold and the dollar, and analyze both
currencies’ behaviors relative to their respective 200dmas. More background information on these
charts appears in my original “Gold Bull Stage Two” essay.
The fall of euro gold
€400 this week is immensely bullish and very exciting! The euro has become the
second-most-important currency on earth so it is a great proxy for
gold’s extra-dollar progress in general. Despite the European nations’
traditional love for invading each other, the rise of the unified European Superstate and its currency appears
unstoppable. Even Asian nations
are now accepting payments in euros for crude oil, other raw materials, and
finished manufactured goods.
The dollar cost per euro is
graphed in red on the left axis and is the best place to start digesting this
chart. The currency countertrend moves that
erupted in the initial days of 2005 drove the euro lower as its secular bull
market entered correction mode.
From January to May, the euro plunged from near $1.35 to under $1.25,
a big move in the usually glacial-slow currency world. Yet euro gold barely rose during this
time as it largely languished under €330.
This conundrum presented a
problem for contrarian investors across the globe. The price of gold should rise when fiat currencies fall, as gold is the ultimate
currency in world history. But
since gold refused to rise materially in euro terms in the first five months
of this year, it was obvious to foreign investors that the US dollar still
dominated gold. The dollar was
rising and gold was grinding lower in the States rather than responding to
But heading into June, gold
suddenly started rising in euro terms, apparently growing more responsive to
major currencies other than the dollar.
Euro gold broke out of its modest early 2005 uptrend and blasted
towards the €350 graveyard in the sky that had slaughtered all previous
attempts to shatter it for three years running. By June gold was rising despite the dollar’s parallel
strength driving euro gold well above €350.
Since these €350
levels had acted as such hardened overhead resistance for so long, a lot of
investors assumed gold wouldn’t be able to hold above €350. Soon it started correcting as expected
in late June. But in July euro
gold bounced at €350, an encouraging action that would happen twice
again in August. The old
€350 resistance that had battered gold for years was increasingly
becoming support for an assault on brave new highs.
As expected, this
€350 breakout emboldened investors around the world. For the first time there was hard data
suggesting that this gold bull was not just the puppet mirror of a dollar
bear, but an independent entity that would rise globally on its own
fundamental merits. Gold surged
around the world in September and blasted to new bull-to-date highs in all
the important currencies including the
euro. And the dollar also had a
strong parallel rally that same month.
Gold’s sharp surge
opened investors’ eyes around the world. Instead of promptly collapsing after
such a fast move, which would have been entirely justifiable technically,
gold buying interest persisted.
Gold spent last month consolidating near €390 rather than
surrendering its gains. Investors
from around the world were pouring enough capital into gold to keep it
relatively high and buoyant despite the dollar’s strength.
The great thing about
investments is their demand curve is inverted. The higher their prices go the more desirable they become to
investors. In the past couple
weeks global gold investment demand surged again driving gold above
€400 for the first time in history. And all this happened, amazingly
enough, not when the dollar was weak but when it was blasting up to major new
rally-to-date highs. Gold is
While extra-dollar gold
charts like euro gold are certainly evidence enough that we seem to be transitioning
into Stage Two, the empiricist in me always wants to precisely quantify
pivotal market events. One chart
I’ve been watching for a few months attempts to do this. It graphs the absolute 20-day returns
of the dollar and gold. Since
calendar months generally each contain about 20 trading days, in effect this
is a rolling-month returns chart.
In Stage One the dollar and
gold moved in nearly lockstep opposition, so if the dollar was up 3% in the
last 20 days then gold would be expected to be down 3%. Indeed this is what we observe from
January to May when Stage One dollar-dependent behavior governed gold. But starting in June at the €350
breakout an amazing thing happened.
The strong negative correlation between the dollar and gold reversed and shot positive.
Rather than moving in
opposition as expected, in June the gold 20d returns soared far faster than
dollar 20d returns waned. Then in
July both returns dropped, in September both rose, in October both fell, and
so far this month both have risen.
The actual calendar-month correlations and their r-square values are
noted above. The white r-square
percentages reveal how statistically likely the behavior in one currency is
able to explain and predict the other’s behavior.
These correlations and
r-squares are computed not on the 20d gains charted above, but on the
underlying daily dollar and gold closes themselves. Check out the extremely high negative
correlations above in February, March, and May. On average in these Stage One months,
91% of the behavior of gold could be attributed to the dollar. From January to May inclusive the
monthly r-square average ran 73%, showing a dollar-dominated gold.
But in June this correlation
actually went positive. Rather than moving in their
long-established lockstep opposition, the dollar and gold suddenly tended to
move in the same direction. While
the 0.44 positive correlation is not large in an absolute sense, as it only
represents a 19% r-square value, it is an enormous
departure from what he had been seeing in gold. This is hard statistical evidence that
the Stage Two developments are real.
Since this radical change
of course in June, two more months have run positive correlations. In September gold and the dollar
matched each other so closely that a very strong 0.90 correlation
emerged. That month 81% of the
behavior of gold could be statistically matched with dollar strength rather than weakness. These three positively-correlated
months averaged an r-square value of 47%, very impressive early in the
Meanwhile July, August, and
October reverted back to the usual Stage One negative correlations. Yet these correlations were very weak
compared to those witnessed in the first half of 2005. The average r-square value for these
particular months was just 26%.
Obviously this is a far cry from the 73% average from January to May. Statistically, verified through
correlation analysis, gold is absolutely decoupling from the dollar.
With gold decoupling, an
obvious question is why are we still seeing any negatively correlated months at all? Why doesn’t the metal just get
on with it and leave the dollar in the dust for good? For a variety of reasons, this Stage One
to Stage Two gold bull transition must
be gradual, not instant.
Both gold and dollar prices
are driven by investors and speculators buying and selling. For four years almost without exception
gold prices were slaved to the inverse of the dollar’s fortunes. Traders are now used to naturally
expecting gold to rally on dollar weakness and slide on dollar strength. In trading well-worn habits create a
lot of inertia and die hard. Many
traders will still be operating on a Stage One paradigm for some time to come
yet until they finally realize that the gold market has fundamentally changed
for the better.
Gradually investors and
speculators will begin understanding the new Stage Two dynamics. Over time the number of traders with
Stage One mindsets will shrink while the Stage Two crowd will grow. Stage Two will only be fully here when
the vast majority of market participants accepts that gold has decoupled from
the dollar to rise or fall on its own fundamental merits and they trade accordingly. No one knows how long this will take.
And measurement problems
make divining the length of this transition even more challenging. For instance, gold and the dollar,
even though they have tended to move in opposite ways strategically over
months, can do anything they want from day to day. The shorter the period of time
considered for any market analysis, the greater the obscuring influence of
random noise becomes. The
calendar-month correlations used above are very short and highly susceptible
to being buffeted by random daily market noise.
And as this transitional
decoupling into Stage Two becomes more pronounced, gold will eventually be
trading totally independently of the dollar anyway. Thus the correlation analysis that was
so powerful while gold moved in lockstep opposition to the dollar in Stage
One will rapidly become meaningless as the respective individual fundamentals
driving both currencies push them in their own independent directions. Stage Two is ultimately not a shift
from negative to positive dollar and gold correlations, but from negative to no correlations.
Our final chart shows where
gold and the dollar have been trading relative to their respective
200dmas. This Relativity principle is
extremely useful for trading markets in secular trends and has served us well
in recent years. If this Stage
Two transition continues, soon the rDollar trends will probably be useless for
gold trading as the dollar and gold head their separate ways. Here
it really highlights the early transition though.
The stylized drawing on the
lower left of this chart illustrates the undulating opposing patterns between
gold and the dollar as multiples of their own 200dmas that characterized and
defined Stage One. Once the
decoupling started in June though, suddenly this mirror-image pattern
vanished. The dollar climbed
farther above its 200dma in a bear rally while gold simultaneously soared
above its own 200dma in a new upleg.
If rGold had continued on
its Stage One path since June, it would have generally followed the dotted
arrow rendered above. Today gold
would probably only be around 95% of its 200dma, which itself would be
lower. If gold had continued
Stage One behavior since June, my best guess is we would be seeing $400ish
gold levels today. Instead gold
decoupled and is now pushing $500 despite the dollar’s considerable
In light of all this
evidence, the thesis that gold is now transitioning into the second stage of
its gold bull is becoming more compelling with each passing week. The behavior of gold relative to the
dollar has unarguably changed since June. We can see it in the charts of gold
graphed in other major currencies and we can quantify it precisely by
analyzing the statistical relationship between gold and the dollar.
With Stage Two dawning, the
implications for investors are profound.
If you visualize a secular gold bull as a decade-plus-long parabola, the Stage One
behavior we witnessed until this past summer is basically a gradually rising
line. All of the greatest rallies
and most exciting uplegs of the past four-and-a-half years are contained
within this modest gradually rising line. The first third of a major bull market
is always the least impressive.
Stage Two is when this
long-term parabola starts curving up.
It is when gains really
start to multiply and mainstream investors around the world start lusting
after gold and driving it relentlessly higher. In dollar terms the rallies and uplegs
of Stage Two will tower over the Stage One events we’ve grown used
to. This bull will get bigger,
badder, and meaner and the opportunities to profit will grow
proportionally. Fortunes will be
While ample opportunities
to profit in this gold bull should abound in the coming years, the particular
opportunity that really strikes me today is the growing anomaly between gold
and gold stocks. Despite
incredibly bullish technicals, gold stocks
continue to lag the awesome surge in gold. Gold ultimately drives gold stocks,
but at the moment gold-stock investors don’t seem to believe that Stage
Two is really coming.
The HUI gold-stock index is
struggling under 250 today while gold is within spitting distance of $500, a
mega-psychological level that will work wonders for gold-bull awareness among
mainstream investors in the States.
A veritable Biblical deluge of mainstream capital could start pouring into gold stocks once gold trades decisively
above $500. Yet the HUI was
actually higher two years ago when
gold was just first breaking $400!
This anomaly cannot be
sustainable. Gold is in a
powerful fundamental bull for global supply and demand reasons, investors
worldwide are bidding it up forcing it to decouple from the dollar, and
it’s the price of gold that drives gold-stock profits and hence
ultimately gold-stock prices. The
elite gold stocks have lagged so far behind this glorious early Stage Two
gold surge that they ought to rocket like a bat out of hell once investors
comprehend their vast potential.
At Zeal we have been
layering in positions in elite unhedged gold stocks preparing for this event
for many months. Our conservative
HUI target for this upleg based on bull-to-date behavior, not even factoring
in the Stage Two impact, is another 33% or so higher from today’s gold-stock
prices. It will probably easily
exceed our expectations. It is
not too late to layer in great gold-stock positions for this upleg now, but
it may soon be.
All of our current
gold-stock and silver-stock trades, which will thrive if the HUI surges to
catch up with gold, are detailed in our acclaimed monthly Zeal Intelligence
newsletter. Please subscribe today before this
unsustainable divergence between elite gold stocks and gold closes and ends
this rare opportunity.
The bottom line is
gold’s behavior is resembling early Stage Two patterns more and more
with each passing week. To see
this metal reach new bull-to-date highs the
same day the dollar reaches yearly highs is really extraordinary and
quite exciting. Gold is
decoupling from the dollar with increasing zeal and one of these months it is
never going to look back. It is
trading on its own fundamental merits, dollar be damned.
Despite all this gold
bullishness, gold-stock investors generally remain wary and worried, a
perfect contrarian sign. Sooner
or later gold stocks will have to acknowledge gold’s unprecedented new
strength and streak higher to catch up.
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