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Correlation With US Dollar Shows Gold Is Still Bullish

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We may see the metal moving slowly higher rather than rallying immediately.

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In Gold Provides Invaluable Insight I wrote that "the historical significance of the RSI being at 70 and the fact that the USD Index has just touched the 50% retracement of the previous rally leads us to anticipate that the recent USD Index rally will stall out and retrace. In addition, a rally for precious metals and precious metal stocks is looking more and more probable."

Since this is exactly what happened, I believe you might want to read my thoughts regarding US Dollar's and gold's next move. Let's begin with the long-term USD Index chart, which is once again the main driver of precious metal prices (I'll write more about that particular topic in the following part of this update).


Source: StockCharts.com

In the previous Premium Update I emphasized the Fibonacci 50% retracement level of the previous (March to December 2009 ) decline. Key Fibonacci levels have historically been reliable in identifying key support and resistance, especially on the US Dollar market.

Consequently, the US Dollar moved considerably lower -- visibly below the trading channel. This non-confirmation of a breakout is a bearish sign for the USD Index, and a bullish one for the precious metals. Please note that once again the RSI at 70 meant a local top in the US Dollar and a local bottom in gold and silver.

Another bullish signal for gold comes from the analysis of its correlation with the US Dollar.



The correlations of the US dollar are starting to become more and more aligned with the metals sector, which is something I was looking to see develop as this is what we've seen in the gold/USD markets right before the huge September to December 2009 rally.

Please take a look at the 30-day column of the values of correlation coefficients for USD and gold/gold stocks -- they're significantly negative for the first time in the last several weeks. Moreover, at the same time, the correlation between gold/gold stocks and S&P 500 is much lower. This means that gold and corresponding equities are once again mostly USD-driven in the short run.

Silver is still highly correlated with the general stock market, but it doesn't invalidate points made above, as silver tends to move closely with stocks because it has multiple industrial uses.

Therefore, the correlation matrix shows further evidence of the return of the highly negative correlation between USD and precious metals. Additionally, the link between gold, mining stocks, and the general stock market is much weaker than it was during the past several weeks. As mentioned earlier, this is positive news for precious metals because the return of this correlation is what I expected to see before the next big move up.



Source: StockCharts.com

In my firm's previous commentary we summarized that the bullish analysis of gold is definitely still intact given the strikingly similar pattern in place back in August 2009, where we had some consolidation followed by a significant rally.

Please note that the similarity is visible not only in the price itself but also in the RSI and Stochastic indicators. Based on the above chart it seems that even if we're going to see gold move a little lower from here, it won't change the bullish implications of the pattern. Let's take a look at the short-term chart for more details.


Source: StockCharts.com

Looking at the short-term chart, don't anticipate for the move to be immediate. Sure, it may be the case that gold rallies right away (that's why I had mentioned opening long positions in metals), but based on the similarity to the late August 2009, it seems that we may see gold moving slowly higher instead of rallying immediately. This means that if we see a small correction that takes gold $20 lower or so, it shouldn't make you worried.

Summing up, the situation in gold is still bullish -- the technical analysis patterns are in place, and the strong negative correlation with the US Dollar serves as a confirmation.


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No positions in stocks mentioned.
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