Gold and Dollar Outlook
"All things come to him who waits -- provided he knows what he is waiting for." ~ Woodrow T. Wilson 1856-1924, Twenty-eighth President of the USA
We have stated several times over the years that we were expecting the dollar to mount several rallies most of which would fail as they have already done so. However we have also stated that at some point in time it will start on a new bull run that could last for quite sometime. Now many will state that this is impossible; how could the dollar recover from such beaten levels. Well take a look at the chart below.
In the middle of 1992 the dollar embarked on a massive rally that lasted well over 10 years and took the index from 78 all the way up to the 120 mark. Note that before this massive rally began there were several early attempts all of which failed and note also that the dollar mounted a steep correction which took it from 129 all the way down to 78 before it finally stabilised. However what is really striking is that the current pattern looks eerily similar to the one that began over 20 years ago. Look at the different coloured boxes to get an idea of this pattern.
Let's examine these similarities
- In 1988 the dollar attempted to mount its first rally and as expected even though the rally was pretty decent it failed. In 2004 the dollar attempted to mount a rally that also failed.
- After the 1988 rally failed the dollar went on to put in new lows; the dollar went on to put in new lows too after the failed 2004 rally. The space between the 1988 rally and the new low was roughly 3 years (88-91). The space between the failed 2004 rally and the then new low was roughly 1 year or 1/3rd the time of the 1988 failure. This is to be expected as the number of market participants has more then tripled since then.
- In 1991 it again attempted to mount a new rally and this one also failed and the dollar went on to put in a new low in the middle of 1992. In 2005 the dollar again mounted a new rally and this one also failed and the dollar is currently putting in new lows. One last thing the dollar put its new low in the middle of 1992 right after the first gulf war which lasted from 1989-1991. It's interesting to note that the dollar is putting in new lows while we are engaged in the second Gulf war.
- Also the long rally that began in the Middle of 1992 took place in the face of several extremely strong positive divergence signals. If the dollar is able to hold above 78 on a monthly basis (note each of the bars represents a months worth of data), it will flash several huge multi decade strong positive divergence signals.
If this pattern is to hold then the Dollar will most likely test or trade below the 78 mark on an intra month basis and then slowly embark on a rally that could last between 12-24 months. As was the case with the 1992 rally there is going to be a lot of volatility in between. Note after a nice start his rally appeared doomed to failure when it almost gave up all its gains towards the beginning of 1995. We expect the same situation to unfold here.
Now from a contrarian stand point of view a strong dollar rally is just a matter of time because it has become the favourite shorting game in town. Everyone expects it crumble and disappear but when we examine its competition, the Euro, the pound etc we find that all these papers are just as worthless. How can one compare one worthless piece of paper to another; its lunacy as there is no standard. If we had gold, or platinum, oil or any hard commodity standard then we would have something to stack all the currencies against but we do not; this action can be compared to a pack of rats jumping from one ship with a big hole onto the next ship with a smaller hole. The problem is that all the ships are sinking, thus they are only delaying the inevitable. The huge short position in the dollar continues to grow larger and larger by the day and when everyone thinks this is the best way to make money the whole thing will fall apart as was the case with the housing sector. A more recent example is the Japanese carryover trade; everyone though the Yen was doomed so they would borrow in Yen and invest in New Zealand bonds that paid much higher yields; but the whole thing fell apart when the Yen started to rally. Thus from a mass psychology point of view we are getting pretty close to this point where the Euphoria levels from shorting the Dollar will hit the extreme zone; we are not quite there yet but we are getting pretty close to this point.
Will this up coming rally in the Dollar affect Gold?
The answer is not really. Take a look at the charts below.
In general the charts show that when the dollar crumbles gold rallies but if you look closer one can find periods when they both rallied and corrected together.
From the beginning of 2006, both the dollar and Gold bullion rallied and they both topped roughly around the same time, give or take a few weeks. Then they both mounted steep corrections; the dollar went to put in a new low and Gold pulled back all the way to 560 ranges. After that they both proceeded to trade sideways with a few upward moves here and there. From October 06 they parted ways with the dollar trending lower and one would have expected Gold to take off as the dollar went on to put in a series of new lows; bullion instead just treaded water. Thus based on this pattern one can conclude that it's possible for both Gold and the dollar to rally at the same time as there is so much liquidity out there that there is more then enough money to chase both classes of investments. The gold market is rather small and if a significant percentage of this money did flow into it, the gold market would explode upwards. In fact we started to get bullish on Gold in early July; below is an excerpt from our July 10th Market Update.
This is a 2 year chart of the XAU index and one can easily see that it has been trading in a channel formation for quite sometime now. The 120 price point level (brown line) represents a zone of extremely strong support and at this point it seems unlikely that this zone will be violated. The trading range for the past 11 month has been rather narrow falling between the 128-144 ranges. The put call ratio in the XAU has suddenly spiked in the last two weeks and thus it makes for a rather good contrarian play. Risk takers can now look to go long via options; however instead of listing a specific entry price via options. We are going to suggest a specific entry point via this index and when this point is hit the suggested Option can be purchased. We are going to put this trade under the Las Vegas Portfolio. Buy the March 160 2008 call when the XAU trades in the 135-138 ranges. Place a 50% stop loss order after you are filled. Market update 10th July, 2007
Our entry range was in the 8.50-10.00 ranges; the last trade on Friday was at 26.40. These options are up in the 250-300% ranges in a very short period of time.
One major factor that everyone forgets is that Gold is not going up only because of inflation as the US has been debasing its currency for decades and for the most part Gold did nothing. The real reason is the huge demand that is emerging from the Asia and the Middle East due to their strengthening economies; individuals in both these zones place a very high value on gold. Thus as their money flow increases their purchases of Gold bullion also increase by the same proportion. Destroy the Asian economy and the demand for Gold will slump however Asia has only just started its upward trajectory so there is no chance of that scenario becoming a reality. If anything the demand for Gold, Silver, and platinum etc will only continue to increase.
New Comments (Sept 22, 2007)
Gold has is now trading well past the 720 mark and the picture continues to get more bullish as a result. This area provided an extremely strong of resistance since May 2006. If you look at the chart above the reason for this is more then obvious; the top of the channel formation and the old up trend line both intersected perfectly at this point to provide an ultra strong layer of resistance. Now that gold has broken through this zone, resistance has now become very strong support. If Gold can trade above the 720 mark for 21 days in a row then $900 becomes almost a certainty. Our next article will examine Silver in detail.
"Experience has taught me this, that we undo ourselves by impatience. Misfortunes have their life and their limits, their sickness and their health." ~ Michel Eyquem De Montaigne 1533-1592, French Philosopher, Essayist