USD Index Likely to Move Lower - What's the Impact for Gold Prices?

By: Przemyslaw Radomski, CFA | Sun, Sep 12, 2010
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This essay is based on the Premium Update posted on September 10th, 2010.

Is it true that the dollar, the yen and Swiss franc may be better investments than gold if the world economy slips back into recession? That's the claim of New York University Professor Nouriel Roubini, famous for having predicted the US housing bust and subsequent recession more than a year before they happened.

Roubini told European economic leaders at a recent conference in Italy that the "US has run out of bullets." More quantitative easing (bond purchases) by the Federal Reserve is not going to make any difference. Treasury yields are already down to 2.5pc yet credit spreads are widening again. Monetary policy can boost liquidity but it can't deal with solvency problems. During the conference Roubini said the dollar, the yen, and the Swiss franc may be better investments than gold if the world economy slips back into recession.

Gold will be one of the preferred safe haven investments in the case of a double dip recession, "But in that situation, things like the dollar, the yen, the Swiss franc have more upside in a situation of rising risk aversion because they are much more liquid than the gold market", he said.

As evidence mounts that the U.S. rebound is running out of steam, we see evidence of investors rushing for bonds and other investments deemed to be secure. The price of gold has risen 14 percent this year. The Swiss franc rose to a record against the euro on Aug. 31 and the yen last month reached its strongest level against the dollar since 1995.

Roubini said:

I believe that gold is going to trade around current level. There are two extreme events that lead to a spike in gold. One is inflation, but we have no inflation in advanced economies. If anything, there is a risk of deflation. The other event in which gold prices go up is the risk of a global financial meltdown, and that tail risk has been reduced because we backstopped the financial system.

Without question Roubini was right about his predictions on the US housing bubble. That does not guarantee that he is right on gold. He doesn't like gold. He got into a famous media fight with Jim Rogers last year when he said Rogers' prediction that gold will reach at least $2,000 an ounce is "utter nonsense." At that time he said maybe gold will reach $1,100.

In fact, in a 2007 video interview on TheStreet.com Roubini predicted gold prices will weaken. Roubini has been proved wrong on gold over several years. Now all we have to do is wait to see if Rogers, who predicted the start of the commodity rally in 1999, is right about this $2,000 target for gold.

In any case, it might turn out that Roubini will be right at some point about dollar, yen and Swiss france outperforming gold. But we believe that in a long range time frame, nothing will beat gold over the next few years. We don't think that gold would form the final top any lower than $5000, and silver any lower than $100.

For projections of what will happen in the near term in the precious metals market, let's turn to the technical portion of the essay. This week the USD Index might be forming bearish head-and-shoulders formation and gold stocks are failing to break above the rising resistance line, just like gold is.

Let's begin with analysis of the Euro Index (charts courtesy by http://stockcharts.com.)

As you may see on the chart below gold has recently moved more or less against the Euro.

Euro Index

At this point the odds favor the outcome that the correction has ended and we may see the rally in the euro resume very soon, which consequently could lead to lower values of gold, silver, and mining stocks.

US Dollar Index

In the long-term USD Index chart, there has been little excitement, much as was the case discussed previously in the Euro Index activity. Since the euro accounts for more than 50% of the USD Index activity, it is not surprising to see lackluster performance in both markets. A strong move in either direction normally has significant impact on the other index and, likewise, lack of direction breeds the same.

There has been somewhat sideways movement for some time now and from this perspective there is little evidence that any dramatic change will be seen soon. The local top may be already in. Should this not be the case, however, it is not likely that the index will move past the 86-level as the uncertainty across global markets appears to be contributing to minimal strength in the USD Index.

The precious metals sector has been somewhat in tune with the USD Index of late, taking weeks into account. For this reason, there is a possibility that any decline in the dollar's value could negatively impact gold, silver, and mining stocks.

US Dollar Index

The short-term USD Index chart shows additional head-and-shoulders pattern development this week. Index levels moved slightly higher as for the fifth week in a row, the trend was the opposite of the previous week, perhaps forming second shoulder. Its completion could mean that USD Index is likely to move decisively below 82-level which is now the neck level.

Since the beginning of August, small declines have been seen with weekly increases sandwiched in between. In fact, Thursday's closing index level was virtually identical to the close of both four and seven weeks ago. Additional declines at this time, especially if the index moves below the 82-level (the "neck" level of the head-and-shoulders formation) could indicate further declines as a continuation of that, which began in June.

Normally, (during most years of the current bull market) declines in the USD Index are positive news for precious metals since they are priced in US dollars. This has however, not been the case in the recent months as gold, silver and mining stocks seem to have been responding to the weakness in the euro rather than to the US dollar. The fact that especially in recent weeks, but generally the whole year, the precious metals have been euro weakness driven speaks volumes about the influence of the European investors on world-wide prices of gold, silver, and other precious metals.

The level of the USD Index is currently at its 50-day moving average, which proved to be a critical resistance/support level many times in the past. In addition, a likely turning point is at hand as indicated by the vertical black lines in the short-term chart.

The 50-day moving average has historically provided both support and resistance especially in recent several weeks. Given the positive relationship between the dollar and precious metals for the past month or so, there is a good possibility that a local top may soon emerge or actually be at hand in the metals markets.

With lackluster moves in both the Euro Index and USD Index continuing for yet another week, major impacts upon gold, silver and mining stocks have simply not been evident. The bearish head-and-shoulders pattern which continues to develop in the short-term USD Index chart may possibly begin to have a negative influence on the precious metal sector. For this reason, gold, silver and mining stocks must be closely watched to enable immediate identification of imminent local tops.

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Thank you for reading. Have a great and profitable week!

 


 

Przemyslaw Radomski, CFA

Author: Przemyslaw Radomski, CFA

Przemyslaw Radomski, CFA
Founder, Editor-in-chief
Gold & Silver Investment & Trading Website - SunshineProfits.com

Przemyslaw Radomski

Przemyslaw Radomski, CFA (PR) is a precious metals investor and analyst who takes advantage of the emotionality on the markets, and invites you to do the same.

His company, Sunshine Profits, publishes analytical software that anyone can use in order to get an accurate and unbiased view on the current situation.

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