A Look at the Euro and Gold

While we focus on the USDX for most moves, which is the truest indicator of asset price direction over the last 10 years or so, the euro is the largest component of the USDX, and thus, the most important single currency to watch to determine the USDX direction.

Perspective is everything.  Here's a quick look at the euro over the last 5 years compared to gold.

Note that the direction is well correlated, with gold outperforming or underperforming in large intervals.  Since October, 2008, gold has been a bit behind the curve because of the forced deleveraging episode that occurred and created the gold buying opportunity of a lifetime.  Since this summer, gold has been gaining ground, as one would expect to see in a gold bull market.

Let's get a little more detail with just the last 6 months of movements.

You can see a very strong correlation with the various up and down movements.  If we consider the euro the constant (which isn't true, but it makes visualizing easier), then we can see that gold has generally been gaining ground since the summer, notably the end of June.  Nonetheless, with every euro upswing, gold rises, and vice versa--only the magnitude of the rise or fall changes.

Now, note the month of November, circled.  The correlation is not strong at all.  We believed we'd see a reasonable consolidation in gold given that we expected the euro to be indecisive, leading to a generally sideways movement in the USDX.  We got the latter, but gold has had a mind of its own as of late.  As we discussed Wednesday, we doubt that the correlation is going away between the USDX and the gold price (though it may be! we have to consider the possibility), so either the euro is due for a big breakout that will allow the USDX to fall, or gold is ahead of itself right here.

Gold has been consolidating since our call on the top on Wednesday.  We've been watching the 1 minute EURUSD charts and the spot gold price, however, and for every minor rise the euro takes, gold rallies strongly.  For every minor dip the euro takes, gold loses very little.  This is seasonal strength and leads us to believe that we will probably not see less than 1070 on the gold price, and it's likely we will not see a dip at all below 1100.

Thus the big question is "what is the euro (relative to the US dollar) going to do next?"

Here are a few things we're watching.

We showed the following chart on Wednesday.  There is a clear up channel for the euro, with strong resistance in the 150 region (150.50 to be exact).  The resistance line (red) and the lower channel up trend line are forming a right triangle.  The euro, at some point, should break to the upside above 150.50.  That will take the USDX down and gold up.  It will push the USDX toward 72 very quickly (and probably put a couple hundred dollars on the gold price).  There's also a chance, however, that the euro breaks below the bottom channel line, around 148.  If we get a close below that level, we'd expect to see a big dollar rally.  We don't think that will happen, so the bullish euro/dollar case is for the euro to break out in the next few days.

There is a potentially bearish case, though.

Conceivably, we could be looking at a head and shoulders top for the euro, with the neckline around 147.50 and a downside target of AT LEAST 142 (1.42).  That would likely set off a larger dollar rally and decline in gold price.  We doubt that this is the scenario at hand given that gold is seasonally strong now, the dollar is being used as a carry trade currency, and there's still more technical downside in the dollar before we have an oversold condition.  But anything's possible...

So, let's simplify this so that we have some points around which to make decisions.

The clear gold bullish case will be for a bullish euro.  The obvious point for trading will be for gold to break out when the euro breaks out above 150.5.  But, if you're looking to accumulate gold, we'd want to anticipate an up move.  So, look for the euro to touch 148 in the next few days and bounce.  If it touches that level and turns upward, gold's probably as cheap as it will get for now.  If it doesn't turn down further before it breaks out, we'd buy the breakout.  For those that don't have enough physical gold in their possession, incrementally buying beginning right here is probably the safest bet--moves in the euro and gold may happen very quickly, and gold is so bullish right now that there's no guarantee we'll see a lower price in the short term.

The bearish case is for a break below the lower trend channel, which is probably a warning that the head and shoulders will be activated.  If that's the case, it may be wise to take profits in more than gold since the dollar will likely rally and cause more assets to sell off.

We're buyers of gold on any bounce in the euro off of 148.  We'd cut any losses if the euro turned again and broke down below 147.50.  If the trend continued such that the USDX rose above its 50 dma, we'd probably short the stock market (needs more study there near that time, if it occurs).  We do not short gold in this environment EVER--there are too many unknowns and gold may go on sudden and monstrous rallies at any point with the reckless behavior of countries, central banks, and politicians.  Note that last year, even during the credit crisis, gold sold off and then began gaining ground even as other assets continued to decline.  Gold is, undoubtedly, the safest investment out there at this time.

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Morning Commentary

It may be too early to call this "the pullback we've been waiting for," but since yesterday's call on a turn in the gold price, it appears that we *may* be getting it now.  Given the euro's potential to break out at any time, we're cautious about the target range that gold may sink to in the short term.  Ideally, we'll see 1070 again, but we may only see the 1100 mark.  We'll post a buy signal when we believe it's time to get back in.

Typically we don't do much commentary on news events simply because that's such a common occurrence.  We may be changing that with more commentary in the near future, key articles, and happenings.  We have a few coming up for the energy analysis we're going to have, but right now, here is one brought to our attention by an Australian reader that we thought was interesting and relevant to our dollar thesis.  Of particular note in this article is the second half of it where there is a technical discussion regarding the next US dollar rally.  It's a thesis and price level that is eerily similar, though not exact, to our own.  Enjoy.


Speculators and Chinese Firms Accumulating Australian Resource Companies and Commodities
By Dan Denning • November 19th, 2009

World class speculators and Chinese firms are accumulating Australian resource companies and commodities. This is the flip side to Australia being a net capital importer and the decline of the U.S. dollar. We rail about Aussie banks borrowing money abroad to invest in a housing bubble at home. But is there an opportunity in all this madness?


Of course there is. George Soros is picking up more shares of gold and potash producers. Mineweb reports that, "Billionaire investor George Soros' Soros Fund Management substantially raised its shares in PotashCorp as well as invested in gold ETFs during the third quarter. In Form 13F documents filed with the SEC, Soros Fund raised its PotashCorp from 1.98 million shares to 2.95 million shares with a fair market value of $266.4 million."


And while China and America bicker over currencies, Chinese firms are scrambling to buy real assets. And while Aussie banks source foreign borrowing to lend in local real estate, Aussie mining firms go begging for bits of capital that would bring world-class ore bodies (and key strategic resources) into production...by local producers and owners.


Take Moly Mines. It's aiming to operate a 10 million tonnes per annum copper and molybdenum mine at Spinifex Ridge in Western Australia. Prior to the credit crisis last year, things were going swimmingly. Molybdenum is a hardening agent used in steel-making. There aren't a lot of economic ore bodies in the world. Moly, according to the research we published in April of 2008 in Diggers and Drillers, had one of the most economic deposits.


But it all went off the rails with the credit crisis. The company couldn't secure the funding it needed to bring the project into production. And the share price fell. That made management amenable to any offer that would secure financing and rescue what was still, by all accounts, an immensely valuable and lucrative resource.


Yesterday, the Foreign Investment Review Board (FIRB) approved a $200 million investment in Moly by China's Sichuan Hanlong Group. It gives the Chinese group majority control in Moly and could see the development of the project at Spinifex Ridge begin in the middle of next year.


Good on the Chinese for finding a great project to invest in at a bargain price. The truth is, Australia has more good mineral and energy projects than the local capital markets can realistically fund (given the preference by the banks for investing in/spruikin property). BHP CEO Marius Kloppers made this point yesterday in a lecture to the Lowy Institute in Sydney.


Kloppers said there are 74 separate resource projects worth $80 billion the advanced stages of planning. Those projects need capital. "'Although clearly not simple," Kloppers said, "a part of the solution lies in continued foreign investment, meaning that both Australia and Australian companies need to be open to this kind of investment, despite its immediate and strategic implications."


What are those "immediate and strategic implications?" Well, up to now, existing Australian shareholders are being clobbered. Those who owned equity in these projects before the credit crunch have been diluted as the firms in question raised money with rights issues or institutional placements.


That's fair enough. Owning shares implies an assumption of risk. The stock market is not a savings account. But the other immediate implication is the transfer of majority ownership of these key projects to overseas owners (including the transfer of a big chunk of income from the assets).


This is what it is. And in most cases, it is not an issue of national security. The truth is, many of these projects won't get off the ground without foreign capital. They will create Australian jobs, export earnings, and share price gains for Australian investors. They will also secure key resources for foreign manufacturers.


There's no sense getting all lathered up about it. The status quo is a result of Australia's status as a net capital importer and the investment decisions made with the money Aussie banks have borrowed. The banks could have chosen to invest in Australian mines. But mining is a risky business.


Is it as risky as property? We don't think so. But the way the Australian property market is currently structured - with the government supporting prices directly through grants and indirectly through miserly land releases, and the banks channeling new lending into the market - it's a rigged game for the banks. Why wouldn't they invest in property? It's certainly in their interest.


Whether there is a national interest at stake in the mining industry is another question. You'd certainly think so, given how much government revenue is derived from royalties and exports. But most state governments and the Federal government seem happy with the current arrangement.


The large producers have an unassailable competitive position. And the smaller explorers and developers are left to their own devices to find capital for their projects. Hey...that's why they call it capitalism!


For investors with the patience to investigate the smaller fry, it's a great market. Our new editor of Diggers and Drillers, Alex Cowie, looks like an insomniac in a coffee shop when he comes to the office each morning. There are literally more good stories than he can possibly research.


The important point is that what might be a national problem - selling of mining projects to foreign investors - is an individual investor's opportunity. You always want to invest where you have an advantage. And as an Aussie resource investor looking at the mid and small caps, you DO have an advantage.


Sure, you may be investing alongside the Chinese, who may be getting a better deal. But there are dozens of smaller projects across the resource spectrum that - as long as the world does not plunge into a second great manufacturing depression - make compelling investment stories.


Murray got back to us with his U.S. dollar index chart. You may recall that the other day we published a chart of the dollar index showing that the short-term and long-term moving averages were in danger of crossing. Murray, a full time technical analyst, basically said our chart looked nice but didn't communicate any useful information to traders about when to enter or exit positions affected by the dollar's decline (or rise).


Murray sent over his chart with a note that begins, "The US dollar index is still in strong downtrend. My last update (to Slipstream readers) said that we needed to keep an eye on the 10 week/35 week Moving Average as the confirmation for any change of trend. Also we needed to see a close above around 81 to confirm a re-entry into the distribution between 78 and 89 formed over the last year."


"None of these indicators are close to being confirmed. So, from a long term perspective, you have to remain bearish the dollar although entry into any short positions is highly risky at this point. Have a look at the chart and you can see that the lowest dotted blue line comes in around a price level of 73 which is close to where we are now."

"The meaning of the lower dotted blue line is just that it is an area where a false break can occur. So even though the current price action doesn't look like it is related to the distribution between 78 and 89, it still could be so beware. You can see from the other ranges that I have shown in the chart that a break through the low of the range saw a move to around that lower blue dotted line and then saw a squeeze from there. The first one saw a move all the way back to the top of the range and the second one tried to re-enter its range but ultimately failed.


"The point being, if you had sold down at the lower dotted blue line on either occasion you would have ended up in a difficult position. The market usually looks terrible at those points, but all too often you will see a reversal there which will at least move back to the bottom of the range.


"In this case that would see a move back to 79ish. And from there a re-entry into the range could see a quick move to the point of control at 84 and on to the highs at 90. I think we will see the Dollar create a low somewhere between 67 and 74 and then we will see a big short squeeze to take out traders in what has become a very overcrowded trade.


"Don't get me wrong," he concludes. "I still think the US Dollar is toilet paper, but it doesn't mean it won't buck around like a wild bronco on its way to fiat currency heaven."


Yee haw!


Dan Denning
for The Daily Reckoning Australia

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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.

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