Important Breakout in
the Dow to Gold Ratio and Its Implications for Gold
By Przemyslaw Radomski, CFA
There are several
indications that the currency war is heating up, the gloves are coming off and
new players are piling into the barroom brawl. First, Australia unexpectedly cut
interest rates, then both the Swedish and New Zealand central bank governors
were making their moves. Way down under, New Zealand’s central bank last week
acknowledging that it had intervened in foreign exchange markets to try to fight
any further appreciation of the country’s currency, known as the kiwi. The New
Zealanders are worried about a runaway property market driven by global money
rushing into the country.
Wait a minute...
that’s exactly the same scenario in Israel.
This week the
Bank of Israel stepped up its efforts to curb the appreciation of the shekel
surprising the markets by unexpectedly cutting its interest rate and announcing
a program to purchase foreign currency. A weaker currency boosts exports, driven
by cheaper prices. The smaller economies are reacting to all the quantitative
easing by the world’s large economies.
bank, headed by Stanley Fischer, one of the most accomplished central bankers in
the world, cut the key interest rate by a quarter of a percentage point to 1.5%
to a three-year low.
Bloomberg that the move came “in light of the continued appreciation of the
shekel, taking into account the start of natural gas production from the Tamar
gas field, interest rate reductions by many central banks – notably the European
Central Bank, the quantitative easing in major economies worldwide and the
downward revision in global growth forecasts.”
Despite the global financial threats, the Israeli economy is still in the black
and healthier than the economies of many European countries. The shekel has
risen by nearly 9% over the past six months, making it one of the
best-performing currencies in the world, after the Mexican peso. Israel’s
central bank also plans to buy around $2.1 billion in foreign currencies.
is heavily dependent on exports, and a strong shekel weakens the competitiveness
of Israel's products abroad.
It was Japan this
year that shot off the latest round in the currency war after announcing
monetary stimulus of historic proportions. Recent steps by the world’s
third-largest economy have become a central concern. The impact of the country’s
aggressive new monetary policy has been making central bankers around the world
lose sleep. Is the Bank of Japan trying to influence exchange rates to give its
exporters an advantage? Other countries might react in kind, which is exactly
what happens in currency wars.
Actually, this is
not surprising to us. The global increase in the money supply and lowering of
interest rates is not surprising because countries will have to keep doing that
in order to keep their exports competitive. It is a currency war and those who
inflate first, get the most benefits. They are short-lived because other
countries will follow and the ultimate result will eventually be huge inflation
on a global scale, but, again, on a short-term basis, the monetary authorities
are pressed not to stay behind others. The comments about the lack of currency
war are not surprising either. Speaking publicly about it would simply encourage
other countries to join it sooner, and those that are already printing more
money don’t want that to happen as it means that the above-mentioned advantage
that they gained would disappear.
gold? Bullish in the long run, nonexistent in the short run.
As we can see,
the great fundamental outlook for precious metals is intact. Let's move on to
the chart section of today’s essay to see how gold’s current technical situation
looks like and therefore how gold can trade in
the following weeks. Before we proceed to the yellow metal itself, let us
begin with the Euro Index long-term chart (charts courtesy by
The index has
declined for the past two weeks and it seems now that we should consider the
possibility that the
head-and-shoulders pattern will be
completed here. Such a completion would take the Euro Index much lower.
The size of the
projected decline after the breakdown and completion of the pattern is roughly
the same size as the height of the head in the pattern. If this decline is
attached to where the breakdown occurred, the projected downside target level
will be about equal to the 2012 low (in the 121 – 122 area). Such a move would
likely contribute to a USD Index
rally. All of this could also be bearish
for gold in the medium term if it all does indeed materialize.
Let’s move on to
gold’s very long-term chart now.
In this chart, we
see a situation quite similar to the declines to 2008, where a sharp pullback
was followed by a continuation of the severe decline. The most bearish factor
here is the shape of the decline, which is a reverse parabola. This formation
results in accelerated declines and makes it difficult to tell how low prices
will go. Although the declines will likely end shortly, the increased volatility
could result in prices moving very low quickly while still being in tune with
pattern. This reverse parabola has been in
place since last October.
turning point suggests that a local bottom
will be seen soon – within the next month, probably about 2 weeks from now.
Keeping both of these factors in mind, we should prepare for even bigger
Let us have a
look at the Dow to gold ratio chart, as an important technical development took
Here, we saw
an important breakout above the declining long-term resistance line. This
has bearish implications for gold.
Please note that the breakout above the previous – much less significant –
resistance line (the red declining line on the above chart) was followed by
major declines in gold.
resistance level for this ratio is at 12.5
and with it currently at 11, declines in gold will surely be needed in addition
to higher stock prices in order for the ratio to move this much higher (it seems
that a move higher in the general stock market will not be enough for the ratio
to move that high soon). The implications are, of course, bearish.
up, the situation remains bullish
for the USD Index. The recent declines in the Euro Index along with the breakout
in the USD Index will likely keep the current bullish outlook in place for the
coming weeks. The implications of the bullish situation here, especially for the
medium term, are bearish for the precious metals. Gold prices declined
last week and pulled
back on Thursday but it still does not seem that this period of decline
is completely over.
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Thank you for reading.
Have a great and profitable week!
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All essays, research and information found above represent
analyses and opinions of Przemyslaw Radomski, CFA and Sunshine Profits'
associates only. As such, it may prove wrong and be a subject to change without
notice. Opinions and analyses were based on data available to authors of
respective essays at the time of writing. Although the information provided
above is based on careful research and sources that are believed to be accurate,
Przemyslaw Radomski, CFA and his associates do not guarantee the accuracy or
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are neither an offer nor a recommendation to purchase or sell any securities.
Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw
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