Can Future Dollar Moves Fuel the Rally in Precious Metals?

By Przemyslaw Radomski, CFA  NOV 13, 2012 1:05 PM

This week, the correlation between the precious metals and the USD Index changed and is now moderate to moderately weak.

 


The US currency is one of the most influential factors behind the price of gold, silver, and other precious metals. When the dollar rises, the latter usually fall in value; when the dollar declines, precious metals usually go up.
 
While the shape of correlation seldom changes, the strength of it is quite often subject to fluctuations. That’s why it should be constantly monitored and this is precisely the reason behind our proprietary tool, Correlation Matrix, which is intended to gauge both current and historical correlations between precious metals and other assets such as stocks and currencies. Knowing current relations, one can act with greater awareness of what’s going on in the market and consequently make better investment and speculative decisions.
 
Correlation measures the average relation between two assets in a given period. This means that there can be times when market action is different from what the value of correlation would suggest. Such times can be insightful. For instance, when dollar rallies and gold refuses to decline, it can be viewed as a sign of the yellow metal’s strength. And such a situation took place recently in the precious metals sector (we’ll comment on it further in this essay).
 
For now, let’s move on to the technical analysis to see what we can expect in the US dollar market and how it could translate into precious metals. We’ll use the USD Index as a proxy for the US currency and start with its long-term chart (charts courtesy of http://stockcharts.com).



We see that the USD Index moved to the declining resistance line once again. Since this line was reached, the upside direction of the Index will likely change and a move to the downside is probable.
 
Now, let’s have a look at the short-term chart.



In the chart, we see a further confirmation of probable moves to the downside. Our target area has been reached (and even slightly surpassed; at the moment of writing this essay, the USD Index is at the 81 level) and the index has corrected to the first Fibonacci retracement level. This means that 38.2% of the preceding decline (actually, almost 50%) has been corrected, and the Index will likely move lower once again given the bearish fundamental situation of the USD Index.
 
The most important implication from this chart is not what will happen to the dollar, but rather the relationship with gold and silver. The precious metals rallied today and last week even without a decline in the USD Index. In fact, the index moved a bit higher last week, but the metals soared strongly. All-in-all, this is a very positive sign for the precious metals sector.



The Correlation Matrix is a tool which we have developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector. We have a very interesting picture this week in the very short-term columns. The correlation between the precious metals and the USD Index changed and is now moderate to moderately weak. What used to be strongly negative is now simply somewhat negative. The reason for this is that gold recently managed to rally without declines in the USD Index and in spite of an actual small rally in the USD Index. This is a positive factor for the precious metals sector, so any implications here are bullish this week.
 
A slightly negative correlation in the last ten days (the very short term) is seen between the precious metals and the general stock market. This is also a positive sign as stocks declined heavily and the precious metals refused to follow. This is indeed a bullish combination for the weeks ahead.
 
Summing up, the case for the USD Index is now slightly more bearish than not, and the implications for the precious metals are bullish at this time. It seems that if the dollar rallies or trades sideways, precious metals will consolidate or rally slightly; if the USD declines, metals will soar.

Thank you for reading. Have a great and profitable week!

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

Twitter: @SunshineProfits
No positions in stocks mentioned.

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