Don't Forget About Gold but Watch the Currencies

By: Przemyslaw Radomski, CFA | Tue, Oct 25, 2011
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Based on the October 25th, 2011 Premium Update.


 

A recent International Monetary Fund report estimates that China exports more inflation to the developing countries than had been previously assumed. For every 1 percentage increase in Chinese inflation, the increase in Asia-Pacific countries is 0.25-0.5 percent. The report argues that the real danger for regional inflation is an up-tick in Chinese output driving commodity prices up. It notes that a 1 percent increase in Chinese output can raise global commodity price inflation by about 5 percent and that the Asian-Pacific region is especially vulnerable to commodity price increases since food and energy compose a sizable proportion of average daily spending.

China's strategy to build up an enormous export-led growth engine has been to use low wages and to keep its currency cheap. Experts estimate that the Chinese yuan is 40% undervalued, making Chinese products artificially cheap. China has also used its huge market to lure Western companies to transfer their next-generation technology to China. Goods are as much "copied in China" as "made in China." Many Chinese realize that it is time to change that template but that will be difficult as long as China's entire system stifles creativity by putting emphasis on rote learning rather than innovation.

The U.S. Senate has recently voted for the Currency Exchange Rate Oversight Reform Act of 2011, which would allow the US to punish any country that manipulates its currency with special duties and import tariffs. The bill is targeted at China, even though it doesn't mention any country specifically. It is unlikely that the bill will pass the House. Even if it does, it is not likely that such a bill will persuade Beijing to change and it could ignite a trade war. It has already provoked a strong response from China. Beijing describes it as trade protectionism, condemning the bill as a serious violation of World Trade Organization rules and a "ticking time-bomb" that could ignite a trade war.

America has to get used to the idea that it will never get those labor intensive assembly jobs back. The differences in wage are too large, regardless of what China does with the yuan.

Keep in mind that China is the world's largest holder of American debt. Or, as "Late Night" talk show host, David Letterman, said recently: "Two things you need to know about taxes. They've extended the deadline to April 18, and when you write your check, just make it out to China."

http://stockcharts.com/Having said so much about currencies, let's not delay any longer and let's turn to this week's technical part with the analysis of currency markets. We will start with the long-term Euro Index chart (charts courtesy by http://stockcharts.com.)

$XEU Euro - Philadelphia Index

In the long-term Euro Index chart, we've seen the index level bounce off the resistance line, move down to the support level and then pull back up to resistance. Now it is at the declining long-term resistance line, which coincides with the 61.8% Fibonacci retracement level (it moved only slightly higher since we created the above chart). These two lines now coincide and this likely helped keep the index from bigger rally this week.

If the index manages to move above the resistance level and hold for three days, the breakout will likely lead to even higher index levels with a target around 143. It's possible that the euro could rally even more. Clearly, the situation is currently tense. A decline from here would confirm the breakdown and a move higher would invalidate the breakdown. As is often the case, time will tell all and what eventually happens will be a key determining factor for the subsequent direction of the currency markets.

On a side note, please keep this chart in mind when you hear talk about technical analysis being no longer valid. The recent reversal after a bullish-hammer-candlestick-pattern coinciding precisely with the Fibonacci retracement level was no coincidence.

USD Index did not manage to successfully break out

We look at the implications for the dollar and for the price of gold as we compare them side-by-side (if you're reading this essay on SunhineProfits.com, you can click the above chart to enlarge it). Here we have some food for thought for those who claim that the correlation between gold and the dollar has disappeared or is no longer applicable. The analogy between today and late 2009 played out remarkably well, as a decline in the dollar coincided with an upswing in gold's price. So where is the next move from here?

With the tense situation in the currency markets, especially with respect to the euro, the situation is quite blurry. The Eurozone tensions have diminished somewhat this week and a move higher for the euro appears to be about a 55-45 likelihood and would, of course, result in a likely decline in the USD Index.

If you recall what we wrote in our last essay on the bullish outlook for gold, you will notice that the current outlook for the USD Index confirms what we wrote then:

We are inclined to think that we're relatively close to an upswing in gold. The point here is if a decline is seen before the upswing, it could simply be the formation of a double bottom with the rally yet to come. So a short move down did not invalidate any rally this week since the rally had not yet begun. We have simply seen a rebound after an initial bottom with a second bottom now being formed. As long as the two support levels in the $1,600 range hold, the outlook remains bullish.

Summing up, a move up in the Euro Index and a move down in the USD Index would have bullish implications for precious metals and the above-mentioned point is very much up-to-date. It fact, it seems that the precious metals market is already moving higher even without waiting for a signal from currencies, which means that if that signal comes, the rally could accelerate.

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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.

Recognizing that predicting market behavior with 100% accuracy is a problem that may never be solved, PR has changed the world of trading and investing by enabling individuals to get easy access to the level of analysis that was once available only to institutions.

High quality and profitability of analytical tools available at www.SunshineProfits.com are results of time, thorough research and testing on PR's own capital.

PR believes that the greatest potential is currently in the precious metals sector. For that reason it is his main point of interest to help you make the most of that potential.

As a CFA charterholder, Przemyslaw Radomski shares the highest standards for professional excellence and ethics for the ultimate benefit of society.

Sunshine Profits enables anyone to forecast market changes with a level of accuracy that was once only available to closed-door institutions. It provides free trial access to its best investment tools (including lists of best gold stocks and best silver stocks), proprietary gold & silver indicators, buy & sell signals, weekly newsletter, and more. Seeing is believing.

Disclaimer: 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 thoroughness of the data or information reported. The opinions published above are neither an offer nor a recommendation to purchase or sell any securities. Mr. Radomski is not a Registered Securities Advisor. By reading Przemyslaw Radomski's, CFA reports you fully agree that he will not be held responsible or liable for any decisions you make regarding any information provided in these reports. Investing, trading and speculation in any financial markets may involve high risk of loss. Przemyslaw Radomski, CFA, Sunshine Profits' employees and affiliates as well as members of their families may have a short or long position in any securities, including those mentioned in any of the reports or essays, and may make additional purchases and/or sales of those securities without notice.

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