MoundReport.com's Monthly
Gold Report
Gold Enters the Twilight Zone
James Mound
JMTG's Head Analyst
Jun 8, 2005
The gold market has for some
time been closely tied to its inverse relationship to the US
dollar. The relationship, created by gold being priced in US
dollars and thus offering varying demand shifts by foreign investors
based on their local currency's relationship to the US dollar,
has recently been neutralized. The US dollar's 10% surge has
had much less of an effect on gold prices as one would have thought
or that I had forecasted, forcing many analysts to wonder why
gold has entered the twilight zone and question what is pushing
that market's price movement. Let's take a look at a few theories,
and then I will tell you what the cause really is.
Theory #1: Market Manipulation
Almost every gold bug I have
ever encountered, whether gold is rallying or selling off (but
especially when it is selling off) uses the concept of market
manipulation, albeit by differing sources such as the US government,
oil dominated countries, etc., to explain the unexpected or non-conforming
price moves in financial related markets. The bottom line is
that this is an inherent part of all markets, and manipulation
is just another word for buyers and sellers. A great example
of this is stock market price support. For a long time the stock
market appeared to find support during bear breaks with little
bullish news, pushing the analysts and market speculators to
suggest government manipulation as the cause. But as time went
on, and the growing public awareness of fund and institutional
automated buying and selling programs increased, the market became
more comfortable with the idea that large volume participants
were the underlying cause of these unknown price shifts and support
or resistance areas. Price manipulation is not the underlying
cause of gold's apparent price stability during US dollar strength,
it is just a word that speculators use to excuse being wrong.
Theory #2: Gold is trailing
the US dollar move (waiting for confirmation)
This is definitely something
I would say - if I believed it to be true. The gold market has
a long history of getting ahead of US dollar moves and lagging
beyond others, and would often appear in hindsight to have offered
great trading opportunities simply playing this relationship.
In my analysis and experience I have this event to take place
during three different market scenarios: 1) Choppy or range bound
trade - the gold market consistently trails or lags the US dollar
move when the US dollar is range bound or channeling, as the
market psychology is often structured around avoiding getting
ahead of itself in this type of market condition. 2) Approaching
critical support or resistance - The gold market stalls its trend
when a major point of US dollar support or resistance is nearby.
This forces the market to play catch-up when this support or
resistance is broken, but otherwise the market has lagged or
held back from overly committing to the move. 3) Market weariness
- the market grows uncomfortable with trading action that suggests
a lack of follow through on major moves (such as what we are
witnessing in the stock market).
The problem here is I just
don't see any of these three events taking place. The US dollar
clearly broke out, no major price resistance is nearby and the
market is witnessing a major trend reversal for the first time
in three years - REACT!
Theory #3: Gold is shifting
to a non-correlated market to US dollars
A good theory, and one that
will eventually come true, is that gold is becoming less and
less correlated to the price shifts of the US dollar. Once this
occurs, the market is free to trade on true supply and demand
fundamentals, flight to quality issues, global politics, etc.
This is certainly an ideal theory and one that will most likely
occur in the distant future, but only when the US dollar stabilizes.
In a decade the US dollar has risen 50% and fell 33%, the later
move in under 3 years! This is not indicative of a stable market
environment. As long as gold prices move in the view of foreign
investors (as their currency becomes more or less valuable) then
the gold market will continue to have a strong correlation to
the US dollar price movement.
The Real Underlying Cause
Many other theories are out
there, but the one that works - that puzzle piece that fits perfectly
into that opening without having to jam it in there is the interest
rate dilemma. Let's just talk common sense for a moment. A strong
dollar is typically caused by a strong or improving underlying
US economy. A strong US economy typically means rising rates
and lower bond prices. Over the past several weeks we have witnessed
a massive bond rally while simultaneously witnessing a bull breakout
in the US dollar. So which is it? Is the economy getting weaker?
Is the dollar strong or is the euro weak?
When France bailed on the EU
constitution the world woke up and paid attention. This was a
massive blow to system that has been gaining global support and
building seemingly permanent strength. The euro is reeling from
this. Here is a currency market that has grown 50% plus from
its inception and now faces its first major blockade in its plight
for global currency dominance. The euro is clearly in trouble,
and this means a strong dollar - but does that mean anything
else should change? The Japanese, and Asia in general, have long
been accepted as big time buyers of gold in the world. While
the Saudis own a bunch of it and the US plays the game, the Japanese
are always there buying when they spot value. Since the US dollar
bottomed and began it's rise to today's prices, the euro has
dropped slightly more than 10% from its highs. During this same
time frame the yen has dropped less than 4%. What we are really
witnessing here is a global currency market that is not seeing
the same move as the US dollar/euro relationship and thus gold
is not reacting. The US dollar index is comprised of many currencies,
but weighted over 50% by the euro, and thus we see the US dollar
move on euro swings but less on yen moves, or pesos or Canadian
dollars for that matter.
This twilight zone we have
entered into with gold is short term. The dollar will force its
will upon the global currency market and the EU issues will fade
as the cause of the next move. When the dollar breaks to fresher
highs it will be because the dollar is strong. This will happen
when bonds drop and interest rates rise and the market realigns
itself with proper inter-market correlation. I wouldn't be surprised
if this happens in the coming weeks so take this as an opportunity
to get short gold $20 higher than it should be and watch the
market return from the Twilight Zone.
Chart
Courtesy of Gecko Software's TracknTrade. **This chart shows a long yen
versus a short euro and the strength of the yen as opposed to
the euro over the past several months. Especially notice that
the most recent spike down in the euro and the support in the
yen lead to a significant spike in this spread.
Jun 7, 2005
James Mound
JMTG's Head
Analyst
email: info@Moundreport.com
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Charts Courtesy
of Gecko Software's TracknTrade
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