The Dollar Move - A Look at Key Foreign Currencies

As a follow up to this morning's gold message, we thought it would be good to forecast the rest of the dollar's move, based on the dollar index's constituent currency makeup.

Looking at yesterday's dollar close, we can already see signs that this move may be about over.  As has occurred in the past with regular repetition, the dollar frequently makes rounded tops.  It appears we're getting one now, with confirmation on the RSI and overbought conditions on the slow stochastic.  Worst case, we'd look to the 150 day moving average as a ceiling.  But that leaves the question, how much further is this rally likely to go?

The euro, yen, pound, and loonie together make up 92% of the US dollar index.  These four currencies, notably the euro and pound, should provide additional visibility into the dollar rise and probable limits.

 The euro will likely move down a bit lower, toward its 150 day moving average--around 1.45 (where we showed support before)--where it has strong support.  That's roughly a 1% down move from here.

The strong support for the yen will likely coincide with the uptrend that's been in place since April.  That's roughly a 2.6% move down from here.

The pound is an interesting case in that it is very, very close to support here.  This is the worst of a bad lot of fiat currencies and is likely ready for a rally with a *potential* inverse head and shoulders pattern on the charts.  It is oversold and appears to be turning around here.  Watch the neckline...

For all intents and purposes, the pound's short-to-intermediate term downside is over for now.

Finally, we have the Canadian dollar (loonie).  The chart is showing a fairly well formed symmetrical triangle that, if it were to break to the upside, would have a target of around $USD 1.01.  It is right at a strong support level, and given that the Canadian dollar is a commodity currency, we believe that gold will either break up or down and the loonie will follow.  The period of indecision is quite obvious on this chart as the symmetrical triangle is almost perfectly formed.  This chart tells us little about the potential dollar direction since the loonie can break either up or down.

Thus, only the euro and yen can provide likely direction for the dollar.

This is the makeup of the US dollar index.  Between the euro and yen, 71.2% of the dollar index direction is determined.  Assuming everything stood still except the yen and euro, the US dollar index is likely to rise approximately .9% from here as the euro and yen reach their target ranges.  That's a target number of around 76.7 on the US dollar index.  76.82 was a previous point of resistance, and thus we believe that line will probably hold--especially with the loonie (and Swiss franc, by way of having gold backing, its very much in the same position) likely to be a follower of the gold price and the pound beginning to rise.  Intraday, we've gotten close to that mark.  The implication is that there's probably a bit more upside in the US dollar (though it's marginal), and by proxy, a bit more downside in gold.  At this stage, we're expecting 1100 on the gold price to hold (or, more accurately, the 150 day moving average will hold) with a possible overshoot to the downside of 1070.  We're not going to hold our collective breath on 1070, however.  If it gets there, consider it a gift.

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Gold's Getting Into the Target Range for Traders

Again, any time along here is a reasonable time to buy physical gold if one is in need.  By the time one pays a markup from a dealer, the impact on the typical retail investor's price points is negligible--you don't want to miss it if it rebounds quickly.

It appears that gold will reach that 1100 range we discussed as the first target.  In reality, we believe it will start seeing buying at it approaches the 50 day moving average, currently at 1101.76.

We are sticking with our previously published buying strategy.  We'll be taking our first paper gold positions today and holding out for a possible short but strong break below the 1100 level in the next few days (no guarantees on this one, which is why we're taking some positions now as gold approaches 1100).

The reason for a possible break to 1070, which we would definitely consider an overshoot to the downside at this time, is because the euro has shown weakness and has bit further to fall, as does the yen.  Meanwhile, there's no central bank on the planet that wouldn't like to take more steam out of the gold price...

Given that we're in a seasonally strong period, however, once gold starts moving up again, we believe it will take off with gusto.  Thus, you're going to have to be quick if you're going to try and grab the bottom.  Instead, we're easing in now and holding some cash for a break below 1100--if it comes at all.

We also really, really like the gold stocks near here.  We'll update this more near the end of the day today.

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Should be Close to Gold Buying Time Again

While there may be some additional downside in the gold price, we don't believe there's much at this stage.  Look, perhaps, for an intraday downspike or a brief period toward 1100, but for investors, this appears to be a good entry point.  Traders should probably wait for confirmation in the dollar and the beginning of the next upswing.

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Currency Intervention in the Works?

Granted, it's early still and things can dramatically change.  However, Friday's action was concerning with the magnitude of the dollar move.  We've waited to see how early forex trading, the gold market, and the stock market began behaving before commenting....

There are two areas that bare close scrutiny, and possible concern.  First, again, is the magnitude of the dollar's move on Friday.  It smashed through the 50 day moving average, which has served as strong resistance since March, and we've technically seen a breakout above the 50 level on the RSI, which implies a possible bull market turn.

The euro and yen have taken a beating, but still show more downside potential.  Strong buying support for the euro will probably come in around the 1.45 level as a worst case.  There is support at the 1.46 level, but it is not as strong, and the triangle breakdown pattern points to a 1.45 level support.

The Bank of Japan is clearly not happy with the yen's strengthening over the last couple of years as a result of the unwinding yen carry trade.  There is more downside here, implying more upside for the dollar.

We usually avoid the conspiracy talk here, but in this case, it may be warranted.  It is our belief that we're seeing a coordinated currency intervention by major central banks, notably the Fed, the Bank of Japan (BoJ), and the European Central Bank (ECB).  The dollar has had extremely negative sentiment, but was not oversold in the big picture sense.  However, the yen was stronger than the BoJ would like, gold was higher than any central bank would like that was interested in buying, and if they're not buying, they definitely don't want a high gold price.  The ECB has been supporting the Fed for some time, and they are under considerable pressure to help the export markets.

What better time to strike than when gold is "frothy" and sentiment on the dollar is ridiculously negative (for good fundamental reasons, we might add...)?

Currency interventions are short lived events--typically.  None of these central banks wants to see a repeat of 2008 with crashing asset prices, so some care would have to be taken to avoid forcing a major deleveraging event.  However, some defense of the dollar would be valuable for all involved and a knock down of the gold price also benefits the entire lot.

Seem far-fetched?

Note that the correlation between rising asset prices and a lower dollar has fallen apart since Friday.  Most commodities held their values well.  Global stock markets held out well enough.  The only negative effect on such a currency move was against gold.  Typically we've advocated shorting the stock market when the dollar broke the 50 day moving average--as long as the correlation was present.  Since the correlation has been present since 2001, either the world is going back to the roaring 1990s (very, very unlikely) or something out of the ordinary is taking place...

Meanwhile, all of the fundamental indicators of credit stress are fine.  In fact, the TED spread was down on Friday, not up as one would expect with such a move.

Of course, we'll know more over time, but at this stage, we're sticking our neck out and calling this a coordinated currency intervention.  It has triggered some selling in the gold market by the weak hands, supported the short term Treasury market,  and lifted some export pressures in Japan and Europe, as well as punished the speculators (probably retail investors...) that were late to the dance. 

Interventions are short term, by definition.  After all, if central banks could control the markets for any period of time, gold would be free, there would be no economic problems in the world, and the banks would never have gotten into trouble.  At this stage, we're looking at the levels discussed on Friday for gold buying.  There is likely more downside, so the first target buy point is probably 1100, not 1130.  There's a bit more downside in the euro to come, and considerable downside in the yen.  The potential for a dollar rally up to 78 exists here over the next month, though we're not forecasting that quite yet.  That will definitely impact our Q1/2010 thesis with the dollar hitting 72 and gold at 1300.  We'll adjust that and provide updates as this situation unfolds.

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Gold Correction Underway?

At the risk of sounding like a broken record, we may finally be seeing the gold market have a healthy correction here.  In brief, assets have a tendency to return to their short term, intermediate term, and long term mean trend.  Although our intermediate term forecast for gold is at least 1300, running into spring of next year, that journey should be made up of smaller rises and consolidations.  A trip too quickly to 1300 implies either some euphoric buying without fundamental support that is unsustainable (sometimes called a blow-off top, a melt up, or a parabolic move) or, in this case, a dollar crash.  While the latter is absolutely possible, as we've discussed before, we don't believe we're quite there yet (just in case, that's the reason one should own some physical gold as insurance).  That leaves the former condition--simply put, we believe that gold has "gotten a bit ahead of itself."

Any correction in gold should be taken as good news for those bullish on the yellow, barbarous relic.  It's quite clear that the bull market has years--by our estimates, upwards of a decade--left to go.  Thus, consolidations represent good buying opportunities and can provide both traders and long term investors with good accumulation points that have a high reward/risk ratio.

Let's take a quick look at gold's action, some likely points of consolidation, and signals that could be used to make short and intermediate term decisions.  [Quick Aside: Our gold report, which is being written now, outlines the information presented here in greater detail.  We're working on getting it out the door now, but it's slowly but surely rivaling War and Peace in length...]

First, as always, the dollar....

As has been the case for a while, the slow stochastic has shown the dollar to be oversold.  Momentum is negative, but at a decision point where it could turn, and the RSI could go either way.  The dollar broke down through a triangle but has quickly rallied today, appearing to be thwarted at the 50 dma (the blue rectangle is our attempt to show what we believe today's dollar trading range will look like in advance).  We consider this a "false breakdown" which will likely be short lived before the downtrend is resumed.  Of course, a breach through the 50 dma that "sticks," meaning there's a clear penetration that holds at least overnight, will be a warning that something else could be in the works.  Note that the weekly and monthly charts do not show the dollar as oversold--yet.  That would be the catalyst for a larger rally.  We just don't believe that's quite in the cards until the spring.  The upcoming gold report, available by request only, has more detail on this condition.

So, why the dollar run up now?  What's the implication on the gold price?  Since the USDX is a basket of currencies, we have to look at the major components that move it, namely the euro and the yen.

Though it broke out last week, the euro has been tentative about moving further over the last 3 trading days.  Today, as noted by the large, red candlestick with the yellow highlighting (meaning that it is an intraday candlestick that is not yet final), the key support level around 150 (150.47, or 1.5047 in real currency terms, to be exact) gave way, implying a false breakout to the upside.  With the euro representing 57.6% of the USDX, obviously this has the most impact on a strengthening dollar.  The slow stochastic and MACD show it could move lower.  The key will be watching the RSI.  Note the red trendline since July just below 50.  There's not much downside room for the euro here.  We would expect a testing of the RSI trendline, which corresponds with a testing of the blue uptrend line which is tracking the 50 dma.  That will not take long to accomplish.  If the retest is successful (meaning it turns back up after it tests the blue trendline), then we will probably see a real, lasting breakout, especially if the slow stochastic is closer to 20 than 80 when the breakout occurs.  From a fundamental perspective, yesterday we saw dovishness from the European Central Bank (ECB) along with considerable jawboning down of the euro and support for the Fed.  It's a talking game, but it can work.  You can watch the replay of the press briefing at http://www.ecb.int/home/html/index.en.html.

Similarly, the intraday, 1 minute chart of the dollar against the yen shows a similar story.

The six month daily chart shows the yen's strongly overbought condition on the RSI and likely support region.  There's still some downside as the move that began around 5 days ago is probably only halfway done.

With both the yen, from an overbought condition, and the euro, from ECB jawboning, moving down against the dollar, this dollar move is not unexpected.  However, in both cases, the corrections will likely be over within the next week--at most.  Notably, the euro will probably not move much further down from here, implying that most of the dollar damage will be done in the next couple of days.

To contrast, gold is overbought on the daily, weekly, and monthly charts--implying that a substantial correction is ahead.  Given that this is a seasonally strong period for gold and the dollar is not oversold, we do not believe that gold will face a large correction until both the dollar is substantially oversold and the seasonally strong period for gold is over.  That will likely occur when the USDX is in the 70-72 range, at some point at the end of Q1/2010 or early Q2/2010.

So, what's the likely damage to gold during this correction, and how long will it last?

First, now that gold and the euro have "caught up" to one another and both are correcting, we believe this correction will be short term (next couple of weeks, at most) and will largely end when both the euro and yen are done.  For the dollar, it is likely that most of the rally will be done today with more possible "sideways movement" as the yen finishes its correction over the next week or so.  The implication is that most of gold's correction will likely happen today as well, with the potential to sell off more since the run thus far has been incredibly strong.

We overlayed the Fibonacci retracement lines from the point of this rally's breakout over the support lines we drew Wednesday to see where the likely support points are to watch.  If the dollar rally ends today, and it may, we may see the lows already at the 1195 area.  In that case, gold will remain dangerously overbought.  We would not add new positions until a more substantial correction occurs, though we would continue to hold our existing positions.

The more preferable target is around the 1130-1135 area.  Gold has found buying there several times already, including during the massive intraday sell-off last Friday (when it touched 1138).  1131 is a key Fibonacci retracement point.  All in all, that's a likely accumulation point given that it would not take too long (a week or less) to pull back to that region.  The timing works well with the anticipated pull back in the yen.

The 50% retracement level occurs near the 1100 level, which is where we originally anticipated the first sell off.  This would move gold, in the short term, to oversold and would a prime buying point at this juncture.

Finally, our old friend 1070 is also both a support point and a key retracement point.  That would gold if we could get such a pull back at this stage--pun intended.

 To each according to his own needs and risk tolerance, but here's how we'd play it.  We'd accumulate physical at 1070 and "paper gold" for trading purposes at higher levels.  Our longer term goal is to accumulate as much physical gold as possible with a low to zero cost basis.  The way we get there is to trade the intermediate term pull backs and accumulate when gold is strongly oversold.  That opportunity will likely come in the spring, but on the odd chance that we see a buying opportunity at less than 1100, we'd take it.

An important note.  If the dollar breaks its 50 dma, we'd hold off on buying anything until it appears that it is rolling over again.  The dollar rules it all, so there is not buying without a confirmation of a lower dollar move through a bearish pattern or a failed attempt at breaking resistance.  Again, we doubt that is in the cards until next year, but anything can happen.

We'll flash a buying signal here if the gold correction moves below the 1190 mark--enough to take a position in either paper or physical gold.

Enjoy the weekend!

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