Originally published by Chamber of Merchants
Just as we anticipated in prior posts, the price of Gold is nearing the $1190-$1200 mark in US Dollar terms. However in almost all other currencies, the price of gold is actually up. The AUD gold price is around $1650. This weekend report will focus on the US dollar (as it largely determines the direction of gold), the big picture for gold and finally I’ll take a moment to discuss what I expect from the Bond market.
The US Dollar
The US dollar has been the little currency that could lately, breaking resistance after resistance. Or, more accurately, the major currencies that it is measured against are doing relatively poorly due to economic and political turbulence. So it is not that the US dollar is so valuable and strong, it is rather a case of the other currencies displaying weakness that leaves the only trade to be a buy if the dollar.
As commodities in the world are measured in US dollars (for now) the upsurge in the US Dollar Index has caused most commodities and precious metals to lose price in US dollar terms.
So it’s imperative that we get a handle of the US dollar and what we should expect in order to manage our probabilities and expectations.
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The Dollar DXY
On the DXY (Dollar Index by ICE) its is clear that the US dollar has just popped above the trading channel. Will the dollar just shoot straight up in a straight line? Usually, any breakout is followed by an short term retest of the support. This often is a final high five before the price shoots into the sky. However, sometimes that high five misses, leaving the price to fall through the support level that was previously the upper channel, which means that the break out was simply a technical signal to get traders on the wrong side while smart money sells into the upsurging volume.
If the US dollar repeats the same pattern observed during the last interest rate increase, then we can expect a pull back some time soon to 100.6 with a failed support sending the dollar lower. However, the next rate hike decision is 14th of December 2016. That is still another 3 weeks away. What if the US Dollar rallies until December? What levels can we expect? (I’ll discuss in the bond market section why I don’t expect a continuous rally in the dollar).
Well, it’s time to pull out the big guns. We’ve looked at the DXY, but there happens to be two other indices for the US dollar which will help get a better feel for the US dollar’s price movement. Enter the FXCM Dollar Index:
Put this one in your Merchant’s bag. The FXCM is a Dow Jones Dollar index which was created in 2011 while the DX which is the normal Dollar Index was established in the 1970’s. (The DXY is the futures contract)
How does using the FXCM Dollar Index compare to using the original ICE Dollar Index?
One major difference is the ICE Dollar index was created in the 1970’s. As explained by the CEO of the FXCM in 2011, the original index is a basket of currencies against the dollar and is more appropriate for what was liquid in 1970’s, not what is liquid today. Because you had all these other currencies merging to the euro, the euro now makes up 57 percent of the ICE index. The ICE dollar index essentially is a souped-up euro and is too heavily affected by it. One may as well trade the euro. It has a higher spread than the euro because it’s got other esoteric currency pairs in there that are wider spread currencies.
The Dow Jones FXCM Dollar Index at inception was in four equally balanced weighting, so it’s 25 percent each. One currency does not move the index. This creates a more balanced and therefore less volatile approach. The other thing about it was that it’s more accurately reflective of the four tightest currency pairs there are. So it’s the euro, sterling, Dollar, yen and Aussie dollar. This gives the customer very much a trading oriented index, which has the tightest spread currencies.
The ICE Dollar Index (DXY) is just an indication of where the dollar is going against the euro, not where the dollar is going in general. The FXCM is much more balanced. It has an Asian component and a European component, not just an overly European component. In the seventies Europe was far, far larger than Asia. Today, that’s not the case. Today, there is much more equal balance in the world. In terms of trading partners with the United States, in terms of capital flow in the world, Asia and Europe are more balanced when it comes to the dollar. It consists of Australia and Japan, and that is balanced against Europe and the UK.
Above I have plotted the FXCM Dollar Index against the US dollar gold price. The correlation is clear. When the Dollar breaks through resistance on the chart, the gold price tumbles. When the dollar falls from support, the price of gold rallies.
So if the dollar continues to rally, it could rally another 2-3% before meeting significant resistance. Does that mean that gold will fall 2-3%?
While it’s possible, it’s not likely. The correlation is not directly proportionate: We are sitting at a 14 year high in the dollar, yet we are only at $1200 for gold which is where it was less than a year ago. I expect extended accumulation in the $1190-$1210 range. I’ll discuss a little gold nugget for gold shortly, but if the US dollar continues to rally, combined with the weakening Australian economy, we can see gold heading back to $1700-$1800 even at these low levels. On the other hand if the US dollar turns back down, the Australian dollar will strengthen somewhat (not as before because our economy is in trouble now) and the gold US price will head up. It’s almost a win win as long you’re in Australian gold miners. Remeber Evolution Mining Ltd (AX:EVN) appreciated from around 40c to $1.80 while the US gold price fell from $1350 down to $1050. Exchange rate buffer.
Now, keep in mind: That the Merchant trades Australian gold and silver miners. There is a buffer provided by the exchange rate. As the US dollar has rallied, while US gold prices have gone lower, the Australian gold price is actually sitting at $1650 +-. That means that if the US dollar strengthens while the gold prices meanders around this level, AUD gold miners will remain and even become more profitable.
The Bond Market and why the Dollar is likely about to tank
Well this is becoming very interesting. In the posts during this week I discussed how foreign countries are liquidating their US bonds. China alone has sold more than a trillion dollars of US bonds since 2014.
Here is the crux:
If I were the Chinese government, I would want to redeem my initial investment at the best profit level possible. That means that when I bring the capital back into China I would want the best exchange rate.
Guess what?
The US Dollar is giving a fantastic exchange rate right now. Therefore I expect those billions of dollars which are currently in US dollars converted from the bond market, to start making its way back into the yuan & yen at an increasing rate. The foreign governments that have lent so much money to the United States may start redeeming their I.O.U’s now. If this is the case, there may be dire times ahead for the US since they need to fund their debt by selling bonds. But if China, Saudi Arabia and Japan are also selling US bonds then the price is going to plummet and the US government is going to struggle raising the funds for the Trump spending spree. Forget the Trump budget: what about simply paying the interest on the 18 trillion they already owe?
And now the market is 94% sure about a rate hike in December?
I said it before: the US Federal Reserve will use any excuse to get out of that rate hike. This may be in the form of a stock market crash, bad economic news or “unexpected event” that will topple the probability for a rate hike. All is not as it seems, so be on your guard.
Finally, the case for gold:
Middle East - Islamic Gold Standard in December 2016
Little known and little publicised:
From December 2016, the entire Middle-Eastern economy will have access to a sector that was not previously available to them: gold.
For me, this makes the picture even clearer as to why the aggressive stop loss hunt has been on in gold. To me, this represents the final opportunity to acquire precious metals and their producers before the Middle-Eastern economy commences trading gold. There are 3 points regarding this development that have made me super-bullish.
“this is a once in a lifetime opportunity for banks, funds and yes…Us.”
1. The market is about to open to 1.6 billion extra people.
Previously, and I was not aware of this, paper trading for gold was not allowed in Islamic nations since it is forbidden to speculate with certain commodities such as gold, silver etc… Gold is now being opened up to Islamic countries for trading, which is I believe will explode the price of gold. Now it makes sense why Australia has seen a recent rise in gold and silver explorers. It also makes sense why the sell-off in gold has been so very aggressive, more aggressive than expected: This is the last chance at accumulation before the doors open to another 1/4 of the worlds population.
2. Physical bullion is required: this is the most profound development for me
In order for trading to be allowed in gold, the Islamic Gold Standard requires that anyone who has traded in gold must be able to take delivery of the physical product. Do you realise what that means? Paper trading of gold is about to get a rude slap in the face. If the Middle East purchases gold, the physical bullion must be available. Now it makes sense why the Shanghai Gold Exchange was established recently: Middle East will probably take delivery from China’s Shanghai Gold Exchange.. Not from Comex United States. This would also explain China, Russia and India’s physcial gold accumulation over recent years.
From what I can tell, this is a once in a lifetime opportunity for banks, funds and yes…us, if we can hold onto our positions.
Take for instance Blackham Resources Ltd (AX:BLK) (as I discussed just moments ago with a fantastic subscriber).
Over the past 4 weeks the share price has been terrible: falling from 77c, to 60c, to 54c… But during that time, Hunter Hall International Ltd (AX:HHL) has purchased over 8 million shares, pushing their holdings to roughly 43 million shares. Selling out at 70c and buying in again around here would have been great. But that is a blip on the radar.
Rather, I see a company that has capital power to manipulate the price, create liquidity and scoop up every last share. Let’s take their 40 million shares and multiply by 40c loss = $16 million dollars in losses so far from 90c. Instead of selling though, they are accumulating.
I wonder who is bumping the price lower and lower each time?
Maybe a company with 40 million shares can break support levels with minimum effort, only to gobble up shares each time. You be the judge.
To continue: Each transaction…I mean EACH transaction after December in the Middle East will be based on physical bullion. That means that gold and silver miners will need to ramp up production. It also means that the shorting of gold in the West may be challenged to a degree since it would create arbitrage for the Middle East. If the West sells gold it does not own, it may still be required to deliver the physical gold at cheap shorted prices to the Middle-East. This will probably cause a disaster and would be avoided at all costs.
3. As pointed out by many articles in the last few weeks, gold production has peaked.
This means that the easy gold, the easily accessible gold has become depleted. So expect shortages compared to demand. If demand outstrips supply, guess what will happen to gold miners? You be the judge.
Conclusion
I was bullish previously on gold and silver due to many factors: The new bull market in gold, the rate of money printing in Europe, China and the US, the threat of stagflation and the bond market bubble which appears to be leaking at an increasing rate.
Now, add to this the fact that the Islamic world is about to start trading in gold.
You get the picture.
I am satisfied with my holdings. The trade is looking better and better, even though right now there is so much smoke and mirrors that the market is being led in one direction while it appears the real money is about to be made elsewhere.
In a bull market, entering just about anywhere will become profitable. Keep in mind that from an Australian perspective gold is holding above $1600 due to exchange rate buffers. So those profit and loss reports are going to look good.
I’ll end off with this: The bounce in gold, if I’m right, will be so powerful, that by the time we get time to respond, it will be too late. Even in that event, entering at a higher price will still become profitable as the bull pushes this market into territories that the analysts never expected.