Today’s beaten-down US dollar is a major short-term risk for gold.
For decades this yellow metal has often inversely mirrored the
fortunes of the world’s reserve currency. Dollar trends are
important trading cues for highly-leveraged gold-futures
speculators, who wield outsized influence over gold prices. So an
overdue mean-reversion rebound rally erupting in the US dollar will
unleash serious gold selling pressure.
Gold
has proven the ultimate universal global money for millennia now,
and its US-dollar price American speculators and investors follow is
simply these currencies’ exchange rate. So flowing and
ebbing dollar levels directly impact prevailing gold prices. Gold
generally tends to rally when the dollar weakens, then sell off when
it strengthens again. The leading dollar benchmark reveals this
powerful inverse correlation.
That
is the venerable US Dollar Index, which was launched way back in
March 1973. This USDX applies a weighted geometric mean to a basket
of major world currencies to track the relative value of the US
dollar. The Eurozone countries’ euro, Japan’s yen, and the United
Kingdom’s pound sterling dominate the USDX commanding 57.6%, 13.6%,
and 11.9% of its total weighting. Three other currencies round it
out.
The
USDX’s sometimes-domineering influence over gold prices has faded
off traders’ radars in recent years. That’s because gold and the US
dollar rallied simultaneously through most of 2019, leading many to
assume that dollar-gold link was broken. But it merely went
dormant, taking a back seat to another big gold driver. Gold
was powering higher on massive inflows of stock-market capital
through major gold ETFs.
The
overwhelmingly-dominant ones are the GLD SPDR Gold Shares and IAU
iShares Gold Trust. Just over a month ago I wrote a comprehensive
essay analyzing this critical
gold-moving
dynamic. In times when stock-market capital is deluging into
gold, this metal can indeed decouple from the US dollar because
stock traders don’t care about it. They chase gold upside
momentum, fueling virtuous circles of buying.
But
much of the time stock traders aren’t frenziedly shunting vast
amounts of money into gold via those major-gold-ETF conduits. In
these more-normal conditions, speculators’ gold-futures trading
dominates gold’s price action. The incredibly-dangerous leverage
extremes these guys run force them to myopically trade
very-short-term time horizons. Nothing motivates them to buy or
sell gold futures more than dollar swings.
This
first charts proves gold’s longstanding opposition to the US
dollar’s fortunes remains alive and well. It superimposes gold’s
price action during this secular bull over the US Dollar Index’s own
along with some of its key technicals. Despite episodes when big
differential gold-ETF-share buying worked to overwhelm and suppress
the classic dollar-gold relationship, it has still greatly
influenced this overall gold bull.
All
secular bull markets are an alternating series of uplegs followed by
corrections. This current gold bull has enjoyed four major uplegs
and suffered three major corrections. And its fourth correction is
underway today. That makes for eight separate bull segments so far,
which are separated here by vertical red lines. In fully 7/8ths of
these segments covering the large majority of this gold bull,
gold inversely mirrored the USDX.
That
happened to varying degrees, depending on how much capital stock
traders were pumping into or out of physical gold bullion through
those big gold ETFs. But major gold uplegs coincided with US Dollar
Index downlegs, and major gold corrections unfolded on USDX rebound
rallies. That’s why the current low US dollar is a serious
short-term threat to gold. The USDX slumped to a 2.3-year low in
late August.
But
this year’s volatile US-dollar action began during mid-March’s
brutal stock panic. That was spawned by governments’ draconian
national lockdowns to attempt to slow the spread of COVID-19. Those
fueled tremendous fear, traders had never seen anything like that.
As stock markets plummeted, there was a stampede for the exits and a
mad dash for cash. Save-haven US-dollar demand explodes
during stock panics!
Before that ugly stock-market selloff cascaded into a full-blown
panic, which is a 20%+ plummeting in two weeks or less, gold climbed
to $1675 in early March. Not coincidentally that was the same day
the USDX bottomed after plunging 4.9% over 12 trading days. Then as
the stock selling intensified and the Fed panicked slamming rates
back to zero, the oversold USDX rocketed higher in a stratospheric
spike.
The
red lines above segment gold uplegs and corrections, which
don’t always precisely match the days the dollar tops and bottoms.
But over the next 8 trading days as the USDX skyrocketed a
stupendous 8.1% higher, gold cratered a horrendous 12.1%! When the
US dollar is surging, gold-futures speculators rush to dump their
long positions and pile on to the selling momentum with new shorts
crushing gold.
While compressed into a lightspeed-fast timeframe, that third
correction of this gold bull had the same strong-dollar driver
as the first two. Back in late 2016, the first correction saw gold
plunge 17.3% over 5.3 months partially on a sharp 7.1% USDX rally.
That catapulted this leading US-dollar benchmark to a lofty
14.0-year secular high! Gold’s second correction shared this same
catalyst of a big-and-fast US-dollar surge.
In
roughly the first half of 2018, gold plunged 13.6% over 6.7 months
on a sharp 8.2% USDX rally. A much-stronger US dollar has proven a
serious short-term threat to gold during this bull, and
remains one today. Those three earlier gold corrections averaged
14.3% losses over 4.1 months, which cascaded on the USDX soaring a
tight average 7.8%. Those are mighty rallies by glacially-slow
currency standards!
After its epic 2020-stock-panic surge, the US dollar was extremely
overbought. So it immediately rolled over into a major downleg.
That combined with huge differential gold-ETF-share demand is the
reason gold was able to soar 40.0% higher over the next 4.6 months.
Had the stock-panic-goosed USDX not collapsed 9.6%, gold’s last
major upleg would’ve been much smaller. The US dollar’s fortunes
still drive gold.
The
USDX’s plummeting last summer was driven by heavily-crowded short
selling in this world’s reserve currency. Professional traders
piled on to the dollar-collapse bandwagon. Not only had the Fed
slashed rates to zero killing yields in dollar-denominated US
Treasuries, but US-government debt was soaring on trillions of
dollars of pandemic-stimulus spending. So dumping the US dollar
became fashionable and popular.
Gold
started shooting parabolic in late July, soaring a colossal 13.5%
higher in less than several weeks!
Extreme
gold-ETF-share buying was the primary driver. But also boosting
gold was the USDX’s sharp 3.2% plunge over that same short
span. Gold peaked at $2062 in early August the same day that this
dollar benchmark slammed into its initial interim low. The next
day’s dollar bounce kicked off gold’s selloff.
The
former was short-lived, as the USDX soon tumbled to even-lower lows
in late August. But with gold sentiment euphoric and gold
technicals extraordinarily overbought, the stronger dollar
had already done its damage. With gold’s upside momentum broken,
the big differential gold-ETF-share buying in GLD and IAU mostly
dried up. Gold consolidated high as the USDX drifted, then resumed
selling off as the dollar bounced.
At
worst by late September, gold’s selloff extended to 9.8% nearing
formal correction territory starting at 10%. During that 1.6-month
span, the USDX merely climbed 1.7%. But if you look at
higher-resolution daily charts of gold and the US dollar since early
August, these competing world currencies are almost moving in
perfectly-opposed lockstep. As during this bull’s past
corrections, gold is back at the mercy of the dollar.
Unfortunately that is really bearish for gold over the near-term.
The battered and heavily-shorted USDX is still way down near major
secular lows. That implies it has a lot more mean-reversion
rallying left to do, fueled by both short-covering buying and
momentum-chasing long buying. And any sustained US-dollar uptrend
will force gold into a deeper correction more in line with its bull
precedent. That’s a big risk for gold!
One
way to quantify the US Dollar Index’s short-term upside potential is
looking at where it has traded relative to its 200-day moving
average during past gold corrections. Dividing the USDX’s daily
close by its 200dma yields the Relative USDX or rUSDX. That is
based on the same
Relativity Trading principles I
analyzed for gold
in another essay a month ago. How high was the rUSDX when past gold
corrections ended?
This
gold bull’s first three corrections finally bottomed at rUSDX levels
of 1.071x, 1.044x, and 1.049x. These average out to the US Dollar
Index surging to 5.5% above its 200dma. Dollar mean-reversion
rallies after major selloffs usually don’t end until considerably
over that key technical baseline. But the highest the rUSDX has
been since late August’s US dollar secular low is merely 0.974x in
late September!
At
best this leading US-dollar benchmark was still 2.6% under its
200dma, which is a far cry from that gold-correction-ending 5.5%
over. And since the USDX has retreated again as of the middle of
this week, it is back down to 3.6% under or a 0.964x rUSDX. The
hammered US dollar has much farther to bounce yet before it
mean reverts high enough to rebalance away oversold technicals and
still-bearish sentiment.
Mean-reversion rebounds fueled by short covering don’t necessarily
need a catalytic driver, but there are still plenty of potential
ones for the USDX today. In recent weeks the US dollar has rallied
in solid up days whenever the perceived odds wane of the US Congress
agreeing on another big round of pandemic-stimulus spending. That
moderates the ballistic trajectory of US debt growth, making the
dollar look stabler.
The
upcoming US-election results could fuel major dollar buying. They
could change the way currency traders are gaming the likelihood of
another big debt-financed government-spending binge. They could
ignite stock-market selling fueling safe-haven demand for the US
dollar. And remember that over 4/7ths of the USDX’s
weighting is in the euro alone! So European events hitting the high
euro could drive dollar buying.
The
European Central Bank could force its rates even deeper into
negative territory, or unleash vast new quantitative-easing bond
monetizations weakening that currency. The Eurozone’s economic
outlook could darken, making the US look relatively more
attractive. COVID-19 infection rates in Europe could keep
resurging, leading to more national-lockdown threats from those
countries’ governments. Lots could happen.
Only
time will tell how high the USDX’s overdue mean-reversion rebound
rally will climb, but precedent suggests big dollar gains are
likely. This gold bull’s past-few-corrections average rUSDX
level of 1.055x when they bottomed implies a lofty 102.2 USDX based
on its current 200dma this week. That is a huge 9.4% higher from
today’s dollar levels, and would make for a total USDX rally of
10.9%! But I don’t expect that.
In
recent years the USDX hasn’t soared back up over 102 without major
surprises, including Trump’s stunning presidential victory four
years ago and this year’s ultra-rare stock panic. Those shocks
helped pull up the USDX’s average rally of 7.8% during this gold
bull’s corrections. That average would imply a USDX topping around
99.4, 6.4% above this week’s levels and making for a 7.8% total mean
reversion.
The
bare-minimum USDX rally gold traders should look for is a 200dma
approach, which is way smaller than gold-bull precedent. The
USDX’s 200dma is running 96.9 in the middle of this week, though it
continues to fall with the dollar so pummeled. Mean reverting back
up to that 200dma now would require the USDX to surge another 3.7%,
bringing its total rally off late-August lows to 5.1%. That’s
troubling for gold.
Even
this lowballed really-conservative dollar-bounce estimate suggests
nearly 3/4ths of the dollar’s gains are still coming! And
gold has behaved very poorly on recent bigger USDX up days. Gold’s
sharp 1.9%, 2.2%, 1.5%, and 1.6% daily plunges that happened on
September 21st, September 23rd, October 6th, and October 13th were
driven by larger 0.7%, 0.4%, 0.3%, and 0.5% USDX up days! They are
a real threat.
The
reason is speculators’ current gold-futures positioning.
These traders are still largely betting on more near-term gold
upside, their outlook is quite bullish. So if the USDX surges, they
have vast amounts of gold-futures contracts they will need to sell
fast to shift their capital out of harm’s way. The crazy leverage
inherent in gold-futures trading makes it exceedingly unforgiving.
These guys can’t afford to be wrong for long.
Each
gold-futures contract controls 100 troy ounces of gold, which is
worth $190,000 at $1900 gold. Yet the margin requirements for
buying or selling each contract are only running $10,500. That’s
the amount of cash traders have to keep in their accounts. Thus
traders can legally trade gold via futures at extreme 18.1x
leverage! At that level a 5.5% gold-price move against futures
bets would wipe out 100% of capital risked.
So
if the USDX continues mean reverting higher and pressuring gold,
major selling will be unleashed in gold futures exacerbating
gold’s correction. This next chart shows specs’ total long and
short contracts as reported weekly in the famous Commitments of
Traders reports. Gold is superimposed on top, and specs’ total
gold-futures buying and selling during each of this gold bull’s
uplegs and corrections are noted.
Compared to when this gold bull’s prior corrections bottomed, spec
longs are still high and spec shorts are still low. In the
latest-reported CoT week before this essay was published, which
ended on Tuesday October 6th, total spec longs and shorts were
running 387.4k and 99.0k contracts. As their green and red lines
ominously reveal, big selling is still necessary before
positioning nears prior gold-correction-ending levels.
As
this gold bull’s first several corrections gave up their ghosts,
total spec longs were running 275.8k, 258.2k, and 368.7k contracts.
That third correction during March 2020’s stock panic was high since
that selloff was so blisteringly fast. But these still average
300.9k contracts, which is 86.5k lower from current levels.
That much selling is the equivalent of 269.0 metric tons of gold, a
big slug that would crush gold lower.
Total spec shorts were running 126.0k, 250.8k, and 67.0k when this
gold bull’s earlier corrections ended, averaging 147.9k. Specs
would have to short sell another 48.9k contracts to get back up
there, which is the equivalent of another 152.1t of gold. So gold
now faces a menacing gold-futures-selling overhang exceeding
421t! That’s a lot of selling that could cascade if a stronger
dollar scares these guys into fleeing.
Even
if this oversold-USDX mean-reversion rally was the only near-term
downside risk gold faced, it is certainly serious enough to demand
caution. All of this gold bull’s prior corrections were driven by
these periodic dollar surges, and today’s fourth one likely won’t
prove any different. But that’s not the only big short-term risk
factor plaguing gold. A couple of my recent essays analyzed some
other ones to keep in mind.
This
gold bull’s fourth correction likely hasn’t run its course yet, with
gold
overboughtness lingering and sentiment remaining way too bullish
for a major bottoming. And the huge differential gold-ETF-share
buying that catapulted gold’s last upleg higher has
gone missing in
action since upside momentum failed. As dollar-driven
gold-futures selling forces gold lower, resulting big gold-ETF
selling could amplify the downside.
Today’s low US dollar, which remains oversold and riddled with
excessive popular bearishness, is just one of several big near-term
risk factors for gold. So odds are there will be more selling to
come in this gold correction. That implies better
buy-relatively-low opportunities are still coming in gold, silver,
and the stocks of their miners. The major gold stocks in particular
tend to amplify gold corrections by 2x to 3x.
Both
speculators and investors should embrace these inevitable
rebalancing corrections, as they yield the best mid-bull buying
opportunities within ongoing bull markets. That is when to
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The
bottom line is today’s low US-dollar levels are a serious near-term
risk for gold. After the dollar’s past big selloffs, it has surged
sharply higher in major mean-reversion rallies. When those unfolded
during this secular gold bull, the yellow metal suffered major
corrections. A rapidly-strengthening US dollar forces gold-futures
speculators to aggressively dump their leveraged positions, which
fuels snowballing gold selling.
With
the US dollar so oversold and bearishness on it so universal, there
are all kinds of potential catalysts to drive its overdue
mean-reversion rally. They could come from the dollar side based on
how pandemic stimulus and upcoming US elections play out. But
economic weakness or health crises in Europe could also hit the euro
boosting the US dollar. Gold remains at risk of further selling
until the dollar normalizes. |