We haven’t touched on
currencies for quite some time (our latest essay was dedicated entirely to
gold: Gold Price in May 2013) now but last time we did, we
mentioned the long-term breakout in the USD
Index, which at
that time was starting to take shape, but as the time wore on it became more
and more significant. This is why in today’s essay we’ll focus mostly on the
U.S. currency, review its current technical situation and its implications
for gold and silver. Let us then jump straight into the chart analysis – we’ll
start with the very long-term chart where the breakout is most clearly
visible (charts courtesy by http://stockcharts.com.)
The index has actually
confirmed a breakout above the very long-term resistance line. It has closed
above it now for three consecutive months (yes, months). While a correction
to the 80 level is still possible in the short term, an eventual move to the
upside is now more likely than not. The closest target level seems to be
slightly above 85 and although the 90 level could be in the cards as well,
for now, we will focus on the first target level at this time.
The situation in the United States has not improved dramatically and the
value of the dollar will have to go down eventually because of the massive
amounts thereof that were created in the recent months and years. However,
please remember that the USD Index is a weighted average of currency exchange
rates, so if other currencies depreciate faster relative to tangible assets
such as gold, the USD Index could actually rally. Another possibility is if
the US situation is bad but it is worse everywhere else, the index could also
rally. Anyway, the above chart suggests the USD index will move higher in the
weeks ahead, though not necessarily immediately.
Let us move on to the medium term now.
In this chart, the picture is not as clear. The bearish
head-and-shoulders formation could still be completed here, but the
index would need to move below 79 and then hold this breakdown. If it moves
above 84, the bearish pattern would be invalidated. Since the long-term
picture is more important and carries greater weight than the medium and
short-term outlooks, it is more probable that a rally will be seen, although
this may not happen right away.
Finally, let’s zoom in even further and see how the short-term situation
In the short-term USD Index chart, we see that the index declined
immediately after the cyclical turning point. A sharp move lower has been
seen over the past few days, though this did reverse on an intra-day basis on
Thursday (perhaps forex traders acted on the bullish 3-month confirmation of
the long-term breakout). This could in fact be a reversal, as moves to the
upside appear possible now. It is, however, a bit unclear at this time. What
should have happened due to the bearish impact of the cyclical turning point
has probably already been seen. All-in-all, the situation is unclear for the
In the long-term Euro Index chart, we see that the index bottomed within our target
area and then moved higher. What’s ahead for the Euro Index is a bit
unclear right now. An analogy to previous patterns suggests a move to the
With respect to gold, previous similar Euro Index trading patterns (such
as in late 2010) coincided with gold moving lower initially and then rallying
strongly (note the decline in late 2010 and early 2011). It seems that gold
could once again move lower before rallying significantly.
Now, let’s take a look at the intermarket correlations to see how the
situation in currencies may translate into the precious metals market.
The Correlation Matrix is a tool which we have developed to analyze the
impact of the currency markets and the general stock market upon the precious
metals sector, (namely: gold correlations
and silver correlations). The short-term impact on the precious metals by
other markets has been very unclear. On a medium-term basis, the impact from
the currency markets is negative. The final bottom for gold, silver and the
mining stocks may very well be ahead. In the long run, the effect of these
other markets is close to zero, and we expect the secular bull market for
precious metals to continue even though the rally may not be seen right away.
Summing up, the long-term outlook for the USD Index is
now bullish, and this could damage the precious metals markets, at least
temporarily. The very long-term correlations between the dollar and the
precious metals have been pretty non-existent. A medium-term impact will
likely be seen however if the USD Index rallies (expect “there was no bull
market in gold, only the bear market in the dollar which just ended” and
similar comments – look at the non-USD gold chart for proof that there was
much more to gold’s rally than dollar’s decline). The metals will probably
respond negatively at first, and then go along with their main secular trend,
which is to the upside.
Thank you for reading. Have a great weekend and profitable week!
Przemyslaw Radomski, CFA
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