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What Does Gold's Lack of Reaction to the US Dollar's Plunge Tell Us?

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The precious metals sector likely needs to decline once again before another big rally begins.

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The US Mint has resumed selling its 2013 American Eagle One-Tenth Ounce Gold Proof Coin at a hefty $195 per coin as of last week. The Mint has set a 20,000-piece production limit for the coin. Sales of its smallest gold coin was suspended by the Mint in late April as year-to-date demand had increased by more than 118% until inventories could be replenished.

Here are some interesting statistics. So far at close to the halfway point of the year, the US Mint has sold more one-tenth ounce gold coins than it did in all of 2012. About 50,000 such coins have been sold thus far for this month, with a total of 350,000 sold so far this year. This compares to total sales of 315,000 such coins sold for the entire year of 2012. The US Mint will continue to limit purchases of the American Eagle one-ounce silver coins. Sales were suspended earlier this year due to record-breaking demand.

Reuters reported Wednesday that the appetite for US American Eagle gold and silver bullion coins is still at unprecedentedly high levels almost two months after the historic sell-off in gold. The US Mint's acting director told Reuters that the mint is buying all the coin blanks they can get their hands on to fulfill the pent up demand for gold coins unleashed by the decline in price.

The facts above suggest that there is fundamental strength in the gold market. On the other hand, some developments this week hint at its short- and medium-term weakness. Let's move on to today's chart section to see how the situation looks like. We'll start with the USD Index short-term chart as we believe that what has happened on the US currency market is the most important event this week (charts courtesy of http://stockcharts.com).



The reason for this is the price action seen on Thursday when the index declined sharply, pulling back a bit before the session closed to end the day very close to the level of the May low. In fact, it is possible that we have seen the final bottom for this correction. The breakdown which we see here below the rising support line was so dramatic that it just might be the decline that the breakdown was supposed to generate.

The most important and interesting implications are seen when we look at the reaction of the precious metals to Thursday's decline in USD Index. Specifically, it is the lack of reaction in these markets that is most striking, even though the dollar index declined by about 1.5 index point and closed the day about 1 point lower. A huge rally in gold, silver, and the precious metals mining stocks would normally accompany such a significant move in the USD Index (say, a $30 - $50 rally in gold), but barely any move to the upside was seen. This is a very bearish indication for the precious metals sector.

Let's see how the euro reacted to Thursday's developments in the USD.



In the short-term Euro Index chart, recall that we have had a head-and-shoulders pattern underway and not yet completed. The question now is, was this pattern invalided on Thursday with the decline in the USD Index and the move to the upside which was seen here? Quite simply the answer is no. The move higher did not take the index above the final Fibonacci retracement level. Drawing parallel lines based on the local bottoms, we see that the upper line has not been reached and it emphasizes that the shape of the head-and-shoulders is still intact.

The index level is not too high above the last shoulder as the formation is skewed. This is due to both higher lows and higher highs. The last shoulder (September-October) has a double top pattern so it's really not so striking that the right shoulder just formed a second top. All in all, this pattern could still be completed and if it is, it will have bearish implications for the euro and the precious metals and bullish implications for the dollar.

Now, let us take a look at the yellow metal to see whether any reaction to the dollar's weakness was seen.


Click to enlarge

We see that gold has rallied a bit more than $20 this week, really not much of a rally at all. The outlook continues to be bearish and the trend remains down. Gold could still decline heavily based on the long-term cyclical turning point, which is due approximately next week. In both 2008 and 2009, local tops formed slightly after the cyclical turning point, so it is possible that the reversal in the downtrend won't be seen until after the cyclical turning point once again, leaving a number of days in which further declines could be seen.

Summing up, the most important development in the currency markets was the heavy decline of the USD Index on Thursday and the striking lack of reaction in the precious metals sector. The implications are bearish for gold, silver, and the precious metals mining stocks, and I think that this sector will need to decline once again before another big rally begins.

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

Twitter: @SunshineProfits
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No positions in stocks mentioned.
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