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What Impact Do the US Dollar and Mining Stocks Have on Gold?

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Unless the gold stocks-to-gold ratio can move above its 2008 low, the picture will remain bearish.

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It seems that everybody is talking about the yellow metal and wondering where the next local top will form. When we take a look at the charts, we see that the price of gold has risen nearly 8% in August as expectations that the Federal Reserve would imminently curb its bullion-friendly $85 billion monthly bond-buying program receded. This is gold's biggest monthly climb since January 2012.

What other circumstances have an impact on such an increase?

The big moves came as Washington and its allies were discussing the military action against President Bashar al-Assad's forces, which were blamed for last week's chemical weapons attacks. According to Reuters, these rising tensions over Syria sparked safe-haven demand and a scramble among investors to reduce their bets on falling prices.

Gold prices rallied above $1,420 an ounce on Tuesday and today the yellow metal extended gains and broke above $1,433 an ounce in early trade. This is gold's highest level since May 14.

As is well known, gold tends to strengthen during periods of rising geopolitical tensions. However, it seems to me that the odds of military action in the near term are very low, and that markets have overestimated this probability.

Who is wrong and who is right? If gold rallied, would it be the metal's final increase in the near term? To see if this week holds any surprises for gold and the precious metals sector, in today's article we'll examine the US Dollar Index, the HUI Index (INDEXNYSEGIS:HUI), and the gold stocks:gold ratio. We'll start with the USD Index's very long-term chart to put the gold stock charts into perspective (charts courtesy of http://stockcharts.com).



The situation in the long-term chart hasn't changed much recently. The breakout above the declining support/resistance line (currently close to 79) hasn't been invalidated and, from this perspective, the situation remains bullish.

Now, let's see the weekly chart.



On the above chart we see that the USD Index declined once again in recent days. However, the medium-term support line stopped the decline. Although we saw a small move below it, the breakdown was quickly invalidated, which is a bullish signal.

As written in my article on gold and the dollar on August 21, 2013:

From this perspective, the medium-term uptrend is not threatened, and the situation remains bullish. Therefore we can expect the dollar to strengthen further in the coming weeks. It seems that it will rally sooner rather than later fueling declines in the precious metals market.

At the moment of writing these words, we have the USD Index more or less where it is presented on the above chart, so its description is accurate.

Now, let's zoom in on our picture of the USD Index and check the short-term outlook.



From this perspective, we clearly see that the recent decline took the USD Index below the 61.8% Fibonacci retracement level based on the entire February-July rally once again. Despite this decline, buyers managed to push the USD Index higher and the short-term breakdown below the above-mentioned Fibonacci retracement level was invalidated. Actually, the USD Index declined once again below this line and invalidated this move once again on Wednesday.

Additionally, when we factor in the cyclical turning point (which we are seeing after a monthly decline), the outlook here looks very bullish. In fact, it seems that the USD Index already started to move higher right at the turning point.

Now that we know what the current situation in the USD Index is, let's move on to the HUI Index and try to find out what kind of impact the mining stocks can have on gold's future price.


Click to enlarge

In this week's very long-term HUI index chart (a proxy for the gold stocks), we saw several attempts in the past weeks and months to move above the 61.8% Fibonacci retracement level based on the entire bull market. As you can see, they all failed.

In recent days, we saw another failure, and the mining stocks returned to below the 61.8% retracement level (approximately at 267). In this way, the breakout above this resistance level was invalidated once again. We have a small move above it on Wednesday, but it doesn't seem like a big and meaningful breakout and it seems that this move will not hold either.

Implications are therefore bearish and the trend remains down even though we saw a breakout above the declining trend channel earlier this month.

Before we summarize, let's turn to our final chart. Today, I would like to present you the gold stocks:gold ratio, which is one of the more interesting ratios there are on the precious metals market. After all, gold stocks have led gold both higher and lower for years (not in the very recent past, though).



On the above chart featuring the gold stocks:gold ratio, we saw a verification of the breakdown. Recently, the ratio reached its 2008 low, but then slipped below it once again.

From this point of view, the trend remains down, and the recent rally is nothing more than a verification of a major breakdown. Unless the ratio can move above its 2008 low, the picture will remain bearish.

Summing up, the medium-term picture for the USD Index suggests that the next medium-term move in the USD will be to the upside, which means that a medium-term move to the downside will likely be seen in case of the precious metals sector. Additionally, the outlook for both mining stocks and the gold stocks:gold ratio remains bearish, and the trend is still down despite the recent show of strength. This is further confirmed by the very recent lack of strength relative to gold. The yellow metal moved to new highs, but miners have actually declined.

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

Twitter: @SunshineProfits
No positions in stocks mentioned.
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