TALKING TECHNICALS

Gold vs the greenback

The two charts shown in this analysis are loosely linked. The first is the US dollar index. This measures the performance of the dollar against a basket of other developedmarket currencies to track the broader strength or weakness of the greenback.

The US dollar index comprises six currency pairs. The currencies included are the euro, pound sterling, Japanese yen, Swedish krona, Canadian dollar and the Swiss franc.

The heaviest weighting in the index is to the euro/dollar pair. What is notable here is that the US dollar index broke down below an area of significant support in July this year, when the price broke down below the 95.50 lateral support level. Notice how that was a meaningful lateral area that provided support throughout 2019 and in early 2020.

A brief spike higher occurred around the peak of the pandemic-fuelled crisis in the financial markets in March 2020. That was caused by a flight to the safety of the dollar. Soon after, however, the Federal Reserve embarked on a huge stimulus drive that effectively increased liquidity into the markets and created a monetary supply inflation in the dollar.

The value of the dollar consequently dropped sharply in the months that followed. The break below 95.50 was a significant technical development that saw the price trade to a two-year low. That 95.50 area that was previously support for the US dollar index now presents significant resistance into a rally. Any move towards 95.50 is likely to be met with selling of the dollar and another leg lower for the US dollar index.

The gold price has largely moved inversely to the US dollar index over the past year. This makes sense from a basic economic perspective. Gold is relatively finite in its supply and is priced in dollars. Thus it serves as a store of value in a world of monetary expansion.

Its price also adjusts when the value of the dollar moves. In the case of the past few months, the gold price has been moving higher as the dollar has weakened. Notice that in the past two months the rapid descent of the dollar has been arrested and there’s a counter-trend consolidation happening in the US dollar index. Similarly, the gold price has been consolidating after it briefly touched $2,000 per ounce in August.

Technically, the weekly chart of the gold price looks to be forming a bull flag pattern. These are typically bullish continuation patterns within a rising trend and they usually break in the direction of the prevailing trend. The trend of the past two years is higher, so the odds favour an upside break from the bull flag pattern. A break above $1,950 will be a bullish breakout and will open a move back to $2,000 and quite possibly higher. This is likely to occur at around the same time as the US dollar index embarks on another leg lower. Keep an eye on these two instruments as their movements are linked to each other.

In a world of monetary inflation and increased money supply, one would expect hard assets with finite supply to perform well. Gold fits that criterion, as does silver and several cryptocurrencies that have performed well recently. ●