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Target Watch: USD Index Above 82.5 Is Deadly for Gold

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The medium-term picture appears bullish for the dollar and bearish for the euro. If the dollar breakout is confirmed, a more powerful rally in it and a decline in gold will likely follow.

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The reasons for gold's decline given in the press were a case of "round up the usual suspects."

There were concerns that China's economy is slowing and that European leaders may fail to stem the debt crisis. As expected, the new French President Francois Hollande challenged Germany's deficit-cutting stance. The euro hit a near two-year low against the dollar on Thursday after dismal German economic data suggested that no country in Europe is immune from crisis. The German data for May suggested the growth in Europe's economic engine that has so far helped the currency bloc dodge recession may be starting to slow.

Last week, the euro dropped sharply to $1.2515, its lowest level in almost two years. All that boosted the dollar, driving the greenback to the highest level since September 13, 2010, against a six-currency basket.

It is likely that the confidence in the US dollar will turn out to be medium-term-lived. It won't be too long before the people will turn to the tried-and-true source of true wealth preservation - gold. Global economic turmoil is likely to continue over the next few years as we lurch from one economic crisis to the next, and gold will be the beneficiary of this. I have no doubt for the long term. Those who invest in gold for long-term wealth preservation don't feel the bumps as much along the way.

However, things may turn out differently in the medium term (several weeks to several months). Let's begin today's technical part with the analysis of the US Dollar Index's very long-term chart (charts courtesy of http://stockcharts.com.)



The index has rallied in spectacular fashion for the past few weeks, and the move is clearly visible even from the very long-term perspective. Three resistance lines have been surpassed, and the index is currently at its last one based on intraday highs. Once this resistance line is broken, if the breakout above the 82.5 level is confirmed, much higher values will likely be in the cards. A move to 87-90 would not be surprising in this case.

Now, let's see how euro did last week.



The euro decline is quite likely responsible for most of the positve upswing seen in the USD Index. If the breakdown is seen here -- below the black neck line of the head-and-shoulders formation -- and if we see the index close below this line for three consecutive days, the Euro Index will likely move much lower and the dollar much higher.

In fact, we have already seen a breakdown in the euro based on weekly closing prices (red line), and this is being verified right now. Whether or not the breakdown is in is a bit unclear, but the situation in the Euro Index surely deteriorated last week.

To finish off today's article, let's have a glance at my firm's in-house developed tool that traces the intermarket dependencies.



The Correlation Matrix is a tool that my firm has developed to analyze the impact of the currency markets and the general stock market upon the precious metals sector. Last week, the coefficients were classic as gold and stocks were positively correlated and gold was negatively correlated with the dollar.

A key factor this last week was how moves in the USD Index were immediately reflected in gold's price. It appears to be very important at this time to watch any move in the dollar and act accordingly. Based on the short-term trend, the USD Index seems likely to be headed above 82.5 even if it has to temporarily correct first (please note that there can be no such correction before the breakout). Lower precious metal prices will probably be seen following such a move.

Summing up, all-in-all, the medium-term picture appears quite bullish for the dollar and bearish for the euro. If the breakout above 82.5 in USD Index is confirmed, a more powerful rally in it and a decline in gold will likely follow.

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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