A Dollar Event to Shake All Markets

04/11/2012 6:00 am EST

Focus: FOREX

J.W. Jones

Chief Options Strategist, Technical Traders, Ltd.

With equity and commodity markets now being capped by a sharp dollar rally, JW Jones writes that the eventual top in the US dollar is the event that will send gold and equities to new record highs.

In the not-so-distant past, arguing that precious metals prices were set up to fall generally elicited a response which was not real pleasant. In fact, during gold’s infamous bull market rally, on several occasions, I called for pullbacks, and regardless of my accuracy, it generated hate mail that seemingly never ended.

Fast forward to the present and hardcore gold bugs remain transfixed on the idea that precious metals must rise. The gold bull market has ended—at least for now—and those still holding the bag are looking at large losses from the all-time highs set back in 2011.

These same gold bugs will cite a litany of reasons why gold should be moving higher, from the unprecedented printing of money by global central banks to the deficit spending and eventual fiscal day of reckoning facing most Western nations.

I do not disagree with the gold bugs that in the long run, gold prices will rally above the all-time highs, but in the short to intermediate term, there are several forces that have the potential to drive gold prices lower.

Gold prices cannot rise continually, regardless of the macro-economic backdrop. Nothing, not even Apple (AAPL) or Priceline.com (PCLN) will rise forever. Eventually, prices will come back down to earth and revert to the long-term mean. It has happened in gold, and it will happen to these stocks at some point in the future; it is simply a matter of time.

Before I discuss my reasoning as to why gold and silver are likely to pull back in the intermediate term, I need to remind readers that I remain long-term bullish on precious metals. While the long-term picture remains bright, the short term is especially murky and dark.

The first primary concern for gold bugs should be the price behavior of the US dollar index recently. The dollar has rallied sharply higher after carving out a higher low on the daily chart (bullish).

The dollar is now on the verge of breaking out above a major descending trend line on the daily chart. Once that breakout to the upside has occurred, it is likely that the recent highs will then be tested and possibly taken out.

The daily chart of the dollar index is shown below:

chart
Click to Enlarge

The US dollar’s price action shown above is not indicative of bearish expectations. In fact, I would argue that the dollar is—and likely will remain—in a bull market in the short and intermediate time frames. However, it is important to recognize that strong periods of volatility will persist, as Ben Bernanke and the Federal Reserve will continue to try to break the dollar’s rally as it tries to grind higher.

The Federal Reserve hates deflation, and a stronger dollar will push risk assets like equities lower. Right now, that is not part of the Federal Reserve’s election playbook. QE3 will likely be announced at some point in the future as an attempt to break the dollar’s rally and put a floor underneath stock prices.

The Federal Reserve has used QE1and QE2 to help prevent economic disaster. Recently, “Operation Twist” has also been used to increase liquidity while keeping the bullish game going. Low interest rates and additional easing adjustments have staved off disaster before, and they will likely be utilized again by the Federal Reserve.

Ultimately, the free market and cycles will exert their will and the Federal Reserve will be left helpless. The day when monetary easing has no major impact is coming, but we are not quite there just yet.

Article Continues on Page 2…

|pagebreak|

In addition to the strength in the dollar index, the gold mining stocks have been under major selling pressure. In fact, the gold miners have recently broken down out of a major consolidation zone that will likely lead to lower prices in the near term.

Unless gold miners can regain the breakdown level on a major reversal this coming week, the most we can hope for is a backtest of the support trend line sometime in the near future once the miners become significantly oversold. The weakness in the gold miners is just another example as to why lower prices for gold appear to be likely in the short to intermediate time frames.

See also: New Gold Event Suggests Drop to $1500

The weekly chart of the Market Vectors Gold Miners ETF (GDX) is shown below. The gold miners are likely to lead equity markets lower in the near term, but lower prices for gold miners is certainly not positive for gold, either.

Obviously, there are several economic factors which could still see gold prices working higher (such as a collapse of the Eurozone), however, at this moment, the likelihood of that outcome in the short to intermediate term is very small.

chart
Click to Enlarge

The European Central Bank and the Federal Reserve are not going to give up that easily. The process of admitting defeat will take time, and global central banks will print money until they feel they have papered over the issue. It is the culmination of either QE3 or other monetary easing around the world that will eventually move gold back above the all-time highs.

Unfortunately, gold will most certainly remain under short-term selling pressure barring any major, unexpected announcements.

The daily chart for gold futures is shown below:

chart
Click to Enlarge

As shown above, I believe that short-term targets to the downside are likely somewhere in the 1,475-1,525 price range. I think gold will find a major bottom near these levels and a strong bounce will play out.

For long-term buyers, I would take advantage of the forthcoming pullback. However, I would be mindful that further selling is quite possible before gold finds a major bottom.

As I said before, the longer term is bright for gold. However, the short to intermediate term will likely see more selling pressure. Until either the dollar tops or some form of major quantitative easing is announced, I would anticipate lower prices for the yellow metal.

In the near term, gold does not look attractive, but the longer-term catalysts for a major move above recent highs are present. The real question has become when and where will the dollar top?

When the dollar tops and gold finds a major bottom, the potential for a monster move higher will become likely, but until then, risk remains high.

By JW Jones of Options Trading Signals

Related Articles on FOREX

Keyword Image
The Fabulous Shrinking Renminbi
09/27/2017 1:13 pm EST

As of August 2015, renminbi (RMB) in payments globally accounted for 2.8 percent of the total, the f...