Will the Breakout in the
USD Index Hurt Gold?
By Przemyslaw Radomski, CFA
Based on the May 3rd, 2013 Premium Update.
Visit our archives for more
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touched on currencies for quite some time
(our latest essay was dedicated entirely to
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
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
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.
zoom in even further and see how the short-term situation looks like.
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 short term.
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 upside here.
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.
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.
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
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