The Euro Index and Gold - The Most Important Pair?
This essay is based on the Premium Update posted on June 8th, 2010.
Markets are skittish and the pace and force of financial crises has taken a frightening turn for the worse. It seems like the fuse gets shorter between each crisis. We barely catch our breath from one when confronted with the next. Looking back three decades a crisis had taken place, on average, every three years. But now, a scant 18 months after the 2008 meltdown, Europe's Greek sovereign debt crisis hit with full, fulminating force. One crisis begets another and it seems like the world's economy is on a treacherous bumper-to- bumper course where any misstatement from politicians can cause a multiple car pile up. Still, the fact worth keeping in mind is that the main stock indices lead, not follow the main economic indicators, such as the GDP growth.
Therefore, when one reads something about the unemployment, GDP, import/export dynamics etc., in the vast majority of cases this information is something that is already factored into prices. Let's just say that the realistic assumption here is that the institutional investors / specialists have better access to information / research teams. At the same time they usually control large amounts of capital and their investment decisions can influence the value of the stock indices. So, if these investors' research suggests that the economic statistics are going to be grim in the future, they are likely to sell stocks right away, before everyone else gets the same information - without waiting for the official numbers to be released. Consequently, prices of stocks are to lead economic statistics.
Naturally, a move in either direction might accelerate after a particular piece of news is released, but the overall trend will most likely be in place much before that.
Moving back to gold - more and more often we hear talk of investors searching for "Safe Haven," as if it's a quest for a Holy Grail.
Take a look at these recent headlines:
- "Bullion Sales Hit Record in Stampede to Safety." (Financial Times)
- "Gold is Safe Haven for Looming Crash." (Seeking Alpha)
- "Gold Ticks Higher On Safe Haven Buying." (AP)
- "Gold Rush: This is a new round of safe haven buying." (Bloomberg)
Safe haven is defined as a currency, stock or commodity favored by investors in times of crisis because of its stability and/or easy liquidation. Gold is a universally recognized currency carrying no counterpart risk, easily portable and unlike fiat currencies, it is nobody else's liability. Early civilizations equated gold with gods and kings, and gold was sought in their name and dedicated to their glorification. Humans almost intuitively place a high value on gold, equating it with power, beauty, and the cultural elite. And since gold is widely distributed all over the globe, we find this same thinking about gold prevalent throughout ancient and modern civilizations.
Sometimes safe haven is mentioned in connection to gold, other times U.S. treasuries and the Japanese Yen. Last month when financial markets plunged in "flash crash" mode, there was talk of capital flight from countries like Germany and Britain to perceived safe havens like Switzerland. Across the globe, investors fled from risky currencies, bonds and stocks to gold, the dollar, the Japanese yen and U.S. bonds.
In mid-May with intense pressure on the euro, we witnessed panicking German dealers and banks desperate to get their hands on Krugerrands, the world's most popular gold coin. At the Rand refinery in South Africa, the phone did not stop ringing all that week and people were buying gold coins like crazy. The Austrian Mint, which produces the popular Philharmonic gold coin, sold more gold in the two weeks from April 26 than in the entire first quarter of the year because of soaring European demand. Still, when the general stock market decline, gold used to move lower in the past years.
There are two reasons why gold has retreated on each of these occasions. The first, gold, as a part of some commodity indices, is automatically subject to liquidation along with the others. The second, gold is sold in order to raise cash or meet margin calls from other sectors. Once nervous investors and distress sellers had been flushed out of the market, sentiment towards gold returned in most of the major crises as well as its status as a safe haven. Still, as mentioned in the previous Premium Update, this might not be the case in the near future, as investors would realize that any declines in gold caused by plunge on the general stock market are only temporary. So far gold's performance confirms this theory.
Throughout history and in all civilizations gold has been valued and cherished. It has offered security in times of political or economic crisis. In extreme situations a few gold coins hidden in a coat lining could mean the difference between life and death. Gold is almost indestructible and does not corrode or rust. The amount available changes slowly and the quantity of newly-mined gold added each year is a small proportion of the existing inventory.
Gold has been a "reserve currency" and a safe haven for thousands of years, and those who understand history know that it will always remain one.
To see what history will say about the gold price this week let's begin this week's technical part with the analysis of the Euro (charts courtesy by http://stockcharts.com.)
In the Premium Update published on May 21st, we identified two strong support levels that the euro was approaching (marked with red circles on the above chart.). Since that time we have seen the euro move lower after having paused briefly. Right now, the euro is declining towards the lower support area at the level corresponding to its 2005 low as well as its mid-2003 high. Additionally, the lower border of the multi-year trading channel is marked by the declining dotted line on the above chart.
These two border levels cross right at the area marked with the red circle. Also significant is the level of the Fibonacci 61.8% retracement level obtained from the euro's 2000-2008 rally. The euro is not likely to fall much further from here. We have illustrated its probable bottom with the red circle, and we believe that there is about 90% probability that the euro would not move below the Fibonacci 61.8% level.
Therefore, it appears gold is driven by the downward movement in the Euro Index. As the euro declines, gold's price increases, because - as mentioned earlier in this update - we see significant demand from European Investors. Speaking of gold, let's take a look at the long term GLD chart.
In the recent Market Alert, we discussed how the self-similar pattern, which we've referred to in recent updates, is no longer reliable. It served us guidance for a few months, greatly improving the accuracy of the analysis, but it does not seem to be much useful any longer. Generally, there is a trade-off between particular pattern's reliability, accuracy, and the time that it is valid. The self-similar pattern was really something outstanding because it provided all of the above benefits for a relatively long time. The reality is that each and every pattern has to end and that self-similar pattern could not have been an exception.
Moving back to the gold market itself, in this week's long-term chart, the more classical RSI tool indicates that we are not in an overbought situation. We saw a decline and then a bounce-back and we may see it go a bit higher than we saw in early-May. The rising support line confirms this. Moreover, we have seen a confirmation in the form of relatively high volume in recent daily upswings.
Summing up, from the USD perspective, the gold market appears to be moving slightly higher. Still, the current rally might be more visible from the non-USD perspective, as the Euro Index is still declining. In other words, if you're trading gold for euro, sterling or other non-USD currencies, there appears to be even more upside potential for gold.
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Thank you for reading. Have a great and profitable week!