Gold Remains Stubbornly Bullish

Seasonal effects aside, gold continues its bull run without a short pause.  Clearly, even though we predicted the dollar would basically move sideways, which it has, gold has not consolidated as anticipated.  It is possible that it is underway now as it has touched 1150 and pulled back overnight.  As we prepare this report, it is testing 1150 again.

Seasonally, this is a very strong period for gold.  The short term chart pattern you see since September, where gold rises quickly, consolidates, retests the recent high, and then rises again is called a "Swiss stair" pattern and is very bullish.  We expected to see another leg in this pattern near the 1100 level, which did not happen.  In fact, gold broke out above the channel without consolidating, and without the dollar moving substantially.  In the background of the chart, in the gray line running opposite to the gold price is the USDX.  You can see that even though it has tipped up as of late, gold has also risen.  Gold is overbought short term on both the RSI and slow stochastic indicators.  Thus the question is "has gold gotten ahead of itself, is gold forecasting a major dollar drop, or has the inverse correlation between the dollar and gold been broken?"

First, let's look at the short term dollar picture.  As predicted, the dollar has moved sideways since we made the short term trade call:

Even though the dollar has been moving sideways, it remains oversold.  In particular, the EURUSD pair has not broken 1.50.  This is of particular significance since the euro is 57.6% of the US dollar index.  Thus, the dollar index cannot move far without the euro breaking out.  As of late, those paying attention will note that there has been a lot of jawboning about the euro to keep it from rallying, which has worked and kept the dollar in a sideways range, showing indecision amongst currency traders.  This type of intervention works in the short term, but not in the long term.

In the euro chart below, you can see that the euro has been steadily rising in a channel, but as soon as it enters the 1.50 zone (150 ish here on this chart noted with the red horizontal line), it find resistance.  The RSI is trending down, and is at the 50 level, which is an important level to hold if the euro remains in a bull market.  You can see the resistance line is forming an ascending right triangle with the lower channel trendline.  At some point, this is going to break to the upside, which will send the dollar further down.  For now, however, the euro has largely been contained against the dollar.  If gold is going to consolidate short term, it will have to do it before the euro breaks out decisively, which will happen within a few trading days.

 

This is probably a good entry point for the purchase of euros between here and the 1.60 area, which was the all time high set in early 2008.  That will be major resistance and will likely be the point when the dollar is in the 70-72 region where the dollar will have one more big rally before the euro breaks 1.60.

Thus, in the short term, gold is overbought but is in its strong season.  The dollar is oversold.  The euro is threatening to break through resistance at 1.50, which will take the dollar lower and should take gold higher.  This is quite the crossroads.  Let's look at a bigger picture.

As our readers should know, we believe gold is in a long term bull market, with an intermediate term target of 1300, and the dollar is in a long term bear market, with an intermediate term target of 70-72.  In fact, we believe that most fiat currencies in this cycle may not make it through this secular bear market--the dollar (and euro, ultimately) included.

Gold and the dollar have been tightly correlated since 1995.  With the exception of the credit crisis period, where both gold and the dollar served as safe havens during the strong deleveraging from July 2008 - March 2009, the dollar has acted inversely to gold.  Sometimes gold leads the price movements, sometimes the dollar leads the price movements.  During the credit crisis, after a brief but intense gold sell-off, both the dollar and gold were positively correlated.  Below is a chart showing correlation between the dollar and gold over time.

A negative number denotes inverse relationships, while a positive number denotes a positive relationship.  The scale is from -1 to 1.  Over the entire history of the USDX and freely traded gold, the correlation has been -.51, which shows a strong inverse correlation and serves as the baseline.  Clearly, the correlation has been stronger than historically typical between gold and the dollar since the mid 1990s. 

Here's another view from the end of 1995.

Note that there are two periods of significance when the dollar rose to any major degree the gold bull market/dollar bear market (those terms are synonymous at this time) began in 2001.  The first period from 2005- 2006 was a long period of consolidation for gold.  The second period, from July 2008 - March 2009, was major gold sell-off period that saw second half buying of gold as a safe haven during the credit crisis.  These two events are very important in the big picture, and we will present some additional information about the effects on gold and what we're seeing around the corner.  That information will be posted here with highlights only--we will only send the full report to people that have requested to receive reports.  Send us an email if you're interested.

So we have strong gold/dollar correlation over a long period of time.  Below is a blow-up of the short term:

We clearly have a disconnect underway.  Either gold is overvalued short term, and due for a correction (which the oscillators show), or the dollar is due to decline again soon (which the pattern in the euro/dollar cross shows).  It is very unlikely that this correlation is going to end soon, so one of these two competing forces is going to have to give--and soon.

As we've noted before, there is a correlation between the dollar and most everything, including stocks.  Yesterday we saw a strong dollar and a resilient stock market.  Today, thus far we've seen a weaker dollar and a weakening stock market.

Clearly, there's considerable questioning of whether or not there should be a dollar rally here.  Investors are wary of a continued falling dollar without a rally, but gold is saying that it expects a dollar fall.  The euro is challenging the key 1.50 level and gold is scoping out a position.

At this stage, we would not add any positions in anything until some decision is reached in the market.  We tend to believe gold is overvalued relative to the dollar decline right here (not relative to the relative value of gold to the outstanding money creation of global central banks--but that's a long term view) and believe we'll see one more pullback in gold and the euro before they rally and sink the dollar in one strong leg down toward 70-72.  We would be buying any significant gold pullback below 1100, with the likely worst case downside in the short term at 1070.  It is only a matter of time before the euro breaks out, and that will likely occur within a few trading days.  Any gold correction will be sharp and fast.  You'll need to be nimble to take advantage of it.  We are still looking at a 1200 or higher target this year, with an extension toward 1300 (and perhaps beyond) in Q1/2010 (along with a 70-72 dollar target before the rally).  If you haven't reviewed it, take a look at our October 8 update where we discuss how we plan on playing this move.  The safe bet is to buy physical gold on pullbacks, but in this case, with an anticipated strong dollar rally on the horizon, trading in the intermediate term may be a good risk to allow accumulation of more physical yellow metal with trading profits in paper gold.  It's a higher risk move, and readers need to know that.  Make sure you have your physical stash at hand first.

Take a look at the historical seasonal market period for gold going back 37 years:

November often has a new high and a sell-off back to the starting point of the drive, and then continues on to a new high.  It's frequently a "whipsaw month."  There's no guarantee that we'll see something like that, but it would be "typical" if we did.

As we close out this posting, take a look at the intraday gold spot chart from Kitco.  It has a head and shoulders pattern just above 1150 that indicates a possibly reversal at hand.  Get your finger on the trigger--we do not believe this sell-off will last long.

That's all for now.  We're going to get back on track with more full market updates as soon as our gold study is complete.  Don't forget to send us an email to get on the list if you want to receive the full report.  You're not going to want to miss it.