Dollar Stealing Gold’s Luster

Courtesy of Doug Short.

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An interesting development is occurring. The US Dollar is in the midst of its strongest rally of the last several years. At the same time, gold and commodities are trending lower. Have you noticed you don’t see as many gold commercials these days? What does it all mean?

It may mean one of the following:

1. Deflation is about to raise its head again as the modest economic recovery stalls.
2. The policies of the US have placed it solidly as the best of the lot at least for now.
3. Gold, the Dollar and commodities will soon reverse their current trends and thereby continue to be range bound – meaning not much has changed.

Let’s look at the charts for deeper insight.

The first is the US Dollar Index. The current rally began in early July. The Dollar appears to be trending slightly upward in a channel formation (e.g. in red) since 2011. Prior to this current rally I categorized the Dollar’s trend as mostly sideways in nature. I left the horizontal red arrow in place because an upside breakout from resistance is not yet confirmed, and until it is we cannot rule out a continued sideways trend with slight upward bias. The horizontal green line represents 5 year resistance up at the 90 level.

The next chart is that of gold. Gold is trending lower, and the red lines may represent a descending triangle formation which is potentially bearish. The sideways consolidation since mid-2013 may be nearing its end.

The final chart is the Goldman Sachs Commodity Index. It also had been trending sideways, but is currently moving lower and bumping on 4-year support (e.g. the red line under 600).

Now let’s consider the three scenarios above. If the current trends reverse themselves – that is, if the Dollar retreats against foreign currencies, and gold and commodities begin to rally, then everything will have remained status quo (e.g. scenario (3)); but if these markets break out of these sideways trends, with gold and commodities moving lower as the Dollar rally continues, then it is more probable scenario (1) or (2) is unfolding.

Scenario (1): Deflation could return. This is the least expected scenario and therefore has some weight. How much deflation talk have you heard? Likewise – how much bear market talk did you hear of in the summer of 2007? We may finally see a capitulation of investor confidence in Fed reflation policy. It’s certainly possible deflationary stagnation is around the corner and we’re near another bear market for stocks, but I believe scenario (2) seems a stronger possibility.

Scenario (2): Number 2 seems more likely to me since the US stock market is making all-time highs as other global stock markets continue to flounder. It’s that simple. Sure -it’s possible the excess money out there has found home in a house of cards US stock market. But if another bout of deflation was imminent, I find it difficult to believe that during this current cycle the stock market would be approximately 27% higher than its previous all-time high. However, I just finished mentioning that the economy and markets can unexpectedly change quickly. So if (2) is more likely than (1), perhaps it is only slightly so.

If (2) is unfolding, it could be that commodities and gold got ahead of themselves with all the inflation talk of the last several years, and they now need to let some air out since the significant inflation some expected now seems less likely. In this scenario stocks could continue to benefit. Remember, it has only been in recent times that all risk assets are so highly correlated. If inflation talk had lifted gold and commodities to stretched-out valuations, and if the US is the best of the lot, then perhaps we are about to return to more normalized asset correlation ratios as gold and commodities break down while the Dollar and stocks continue to rally. This realignment of correlations had already begun. Perhaps it now gains momentum.

In conclusion, look to see if gold breaks out of the descending triangle to the downside and commodities move lower through support, and if the Dollar continues to rally. If they do, then look for any deflationary signals (e.g. falling real estate values, falling consumer confidence, falling investor sentiment, etc…). If these deflationary signals present themselves, then look for risk assets to remain correlated and for gold and commodities to potentially lead stocks lower. On the other hand, if the deflationary signals do not present themselves as gold and commodities move lower, then maybe the US is the best of the lot. If it plays out as such, it’s possible this scenario could underpin stock market values. Finally, please remember that breakouts have not yet occurred, and the Dollar, gold and commodities may remain in sideways consolidation patterns.

Dominic Cimino
Chief Investment Strategist
Financial Advisor
Preferred Planning Concepts, LLC
2800 South River Road #240
Des Plaines, IL 60018

Registered Representative, Securities offered through Cambridge Investment Research, Inc., a Broker/Dealer, Member FINRA/SIPC. Investment Advisor Representative, Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Preferred planning concepts, LLC & Cambridge are not affiliated.

© 2014, Dominic Cimino of Preferred Planning Concepts, LLC (You can explore the services offered by Preferred Planning Concepts by viewing us on our website at www.ppcplanning.com) Any redistribution, reprinting, or reference to this chart or content is allowed so long as reference to the author and source is acknowledged.

Important Disclosures

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