Precious Metals Benefit From a Shift in Currencies

By Przemyslaw Radomski, CFA  SEP 20, 2012 3:15 PM

No market can move straight up even if fundamentals are positive as is the case with gold and silver.

 


We recall with some nostalgia that it was last year on September 6 that gold hit an all-time high of $1,923. This, of course, reminds us that a month before that, the credit agency Standard & Poor’s stripped the United States of its AAA rating on its bonds after partisan wrangling over raising the government's debt limit led the nation to the brink of default. And now in addition to nostalgia, we get a feeling of déjà vu. The US recently received another warning of a credit downgrade, this time from Moody's Investors Service. The credit agency said last Tuesday that it would most likely cut its AAA rating on United States government debt, probably by one notch, if Washington's budget negotiations failed. This does not bode well for the US dollar in the long run.
 
Let’s move to the situation in Europe. When George Soros speaks, people usually listen. Soros is a strong supporter of European integration, but a longtime critic of Germany’s eurozone crisis management. In his usual forthright manner, Soros recently said in a speech that Europe’s recession will intensify and spread to Germany within six months:
 
"The policy of fiscal retrenchment in the midst of rising unemployment is pro-cyclical and pushing Europe into a deeper and longer depression,” Soros said. “That is no longer a forecast; it is an observation. The German public doesn’t yet feel it and doesn’t quite believe it. But it is all too real in the periphery and it will reach Germany in the next six months or so."
 
Soros said Germany needs to abandon its demands for austerity in other countries and embrace the continued fiscal unification of the region or leave the eurozone itself. (Recently, German politicians, led by Chancellor Angela Merkel, have begun signaling greater comfort with monetary debasement.) Soros also said it would be preferable for Germany to stay in the eurozone and work to boost growth, activate a debt-reduction fund, and guarantee common bonds. All in all, it seems that both the US and EU are going to debase their currencies, each in hope of gaining a competitive advantage in exports and devaluing its own debt. Who will win this race? Whether it will be the US or EU that will manage to “solve” more problems by printing money, we know that clear winners in the long run will be gold and silver investors and charts appear to confirm that (charts courtesy of http://stockcharts.com.)
 

 
Let’s take a look at the long-term USD Index chart. We focus on this chart to analyze the USD Index because last week’s moves have long term and medium term significance.
 
The major breakout was invalidated last week and the move below the key resistance level is being verified right now. Breakout’s invalidation was truly a very unlikely development. Just by the term itself, breakouts normally hold and are generally not invalidated. The previously broken resistance line normally becomes a support line.  With the breakout being invalidated last and this week, a true sign of weakness in the USD Index is clearly seen and points to a bearish outlook for the months ahead. As you will see in the following part of this essay, it has profound bullish implications for the precious metals market. Meanwhile, let’s take a look at the European currency.
 

 
In the long-term Euro Index chart, we have quite the opposite situation as compared to the dollar. Now it’s not that the euro is showing strength, but rather the dollar has simply lost much of its appeal relative to the euro and this makes the euro look strong.
 
The breakout above the key resistance line in the euro was a major bullish factor and the size of the move that followed after the breakout has already verified it. The picture is clearly bullish. To see how this shift in currencies could impact precious metals in the following weeks, let’s have a look at our Correlation Matrix, intended to gauge the intermarket correlations.
 

 
The developments in the markets last week have bearish implications for the USD Index and have created a bullish outlook not only for metals, but also for stocks. This combination has resulted in a rosy picture for the precious metals. The classic mode is in place in this week’s correlations as the miners have moved with stocks and in the opposite direction of the dollar.
 
The previously discussed Fed announcement of the endless QE3 along with a promise to keep interests rates at or near zero through the middle of 2015 helped to keep these correlations intact. The outlook for the precious metals – based on USD Index and stocks – is bullish for the medium term.
 
Summing up: The medium-term picture for the Euro Index is now bullish, and the opposite is the case for the USD Index.  Taking into account the correlations between the USD and precious metals, the medium-term outlook for the latter is clearly bullish. Please keep in mind that what’s very likely to happen in the medium term, is not always what’s the most likely outcome in the short run. In this case, we believe that a short-term correction will be seen in a few days (perhaps when gold moves to its February highs, and that the uptrend will resume thereafter. Simply put, no market can move straight up even if fundamentals are very positive as is the case with gold and silver. At this time, it seems that the metals have risen too far too fast and that they need to take a breather.

For the full version of this essay and more, visit Sunshine Profits' website.

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