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Did PM's just break out? Gold and the USD

By Przemyslaw Radomski      Printer Friendly Version
Jun 27 2008 4:22PM

www.sunshineprofits.com

With the Fed’s latest decision regarding interest rates the question on precious metals investors’ minds in how it will affect prices of gold and silver in the future. On one hand it means that there is no immediate rise in the amount of money chasing tangible assets. This would very likely mean a rise in the price of most commodities, including precious metals. On the other hand it is also true that during the previous bull market we had precious metals rising along with interest rates, so higher interest rates would not necessarily mean plunging prices.

The Fed did what the market was expecting it to do, so this decision has already been in the price for some time. That doesn’t mean that market’s perception will not change in the future – on the contrary, it probably will, and we are watching for clues that might tell us that this situation has materialized.

Since this information has already been in the price, the prices themselves can tell you a lot about this decision and especially – market’s attitude toward it. This is where we come in. Knowing market’s perception toward current events might give us indication of the future direction of the price.

Where does one look if one wants to check what the tendencies are? The charts – of course. In this essay we have prepared two charts (courtesy of stockcharts.com), on which you can see how gold reactions changed along with dollar’s rise.

We have discussed the correlation between US Dollar Index and the price of gold in one of our previous essays. Since understanding it is crucial grasp the following analysis, here’s a quick reminder:

'Let's say (theoretically - just for the sake of this essay, as the fundamental situation is way more complicated) that the main factor that decides where the price of gold will go is the value of the US Dollar Index. The undeniable reason is that gold is priced in the USD and, therefore, virtually has to respond to its up- or downswings, by moving in the opposite direction. If the value of gold was perceived as constant by the investors from all over the world and the value of the currency in which it is priced, falls, then in order for the price of gold in their respective national currencies to be stable, it has to rise in terms of US Dollars. If the price of gold did not rise as the US Dollar falls, then foreign investors would see price of gold fall in their national currencies. Unless foreign investors changed their mind about the value of gold, they would start buying gold, as it now is cheaper for them than it was when they thought the price reflected gold’s value. As they would purchase, the price of gold in all currencies would go up (including USD). For people who make transaction in the US Dollar it would seem as if the price of gold as just went up out of the blue, when in fact it would be their Dollars that lost value, while gold’s 'real' price was not affected. Like we stated earlier, there’s more to this correlation between USD and price of precious metals than just what we mentioned above, but it's enough to make a few key points in this essay.'

When one looks at the US Dollar Index and compares it to the price of gold it becomes obvious that gold stopped following its main fundamental factor. Gold has managed not to establish a lower low despite a higher high in the US Dollar Index. This is a very positive sign for all people, who are waiting to see some strength in the yellow metal. Please take a look yourself.

The scale on the US Dollar (right) axis is inverted, so that you can better see how gold’s reaction toward USD changes.

Since the beginning of May, gold mostly stopped reacting to USD strength. Sure – we had days, when dollar was rising and gold was falling and vice-versa. However generally speaking, dollar’s rise was not accompanied by falling gold prices. Though we expected it, no new lows were made in gold and silver.

This can be also observed in the Gold to Anti-Dollar Ratio (Gold to USD Index but in reverse order, such as on the chart above) – please see chart below.

Clearly gold’s attitude toward rising dollar has changed since the day it established a low at the beginning of May.

This means that gold is likely to rise in the future and the breakout which has just occurred has a high probability of NOT being another fakeout leading to further declines. This has now been confirmed by numerous factors, especially the precious metals stocks. In our last commentary we outlined a resistance level that was supposed to stop the fall. Despite the steep decline in the general stock market, PM stocks refused to go lower. This, combined with yesterday’s breakout on high volume gives us a high probability that we will not go lower for at least several days, more likely weeks. That is IF we get lower, which is not that probable given aforementioned factors.

Summing up, our best guess is that we have just witnessed a breakout, which could take gold again into four digits, or very close to that level. Time will tell whether new highs will be achieved right away, but we would be cautious with predicting that. We will be monitoring the situation closely.

Of course the market might prove us wrong, as nobody can be right 100% of the time. We have just sent out an update to our registered Users with details on our preferred method of profiting on this situation. Should our view on the market situation change substantially, we will send another update to our registered Users along with suggestions on how to take advantage of it.Register today to make sure you won’t miss this free, but valuable information. You’ll also gain access to our Tools section. Registration is free and you may unregister anytime.

P. Radomski
Editor
Sunshine Profits

 

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