Saturday, November 13, 2004
Issue Contents:
| 15:25 | Focus: The Dreaded Yellow Metal Its time to consult the road map and watch for on-ramps or u-turns. |
Focus: The Dreaded Yellow Metal
I’ve been writing a lot about currencies lately, but really everyone these days are talking about currencies – central bankers in numerous countries, market strategists, international companies – the entire financial markets world is focussed, rightly so, on the state of the US dollar.
There is a tendency for contrarians to assume that when everyone sees an issue, then the end is not nigh, rather surprise is more likely to be around the corner. Certainly this has proven true time and again. Almost invariably when Time or other major media are clamoring that the “end of the stock market is here”, its actually time to get long in a big way.
But the contrarian approach, poetically beautiful as it is, doesn’t always work, which is why we add to instinct a healthy dose of reality, provided primarily by our price charts.
As any gold watcher knows, the price of gold (POG) is tied closely, and inversely, to the US Dollar and thus we monitor the state of the greenback whether we are trading currencies or not. Constructing a road map for Gold therefore starts with the dollar.
Greenback Road Map
Wither the dollar? Provided a reversal doesn’t set up soon, we can establish an initial first target by extrapolating the price decline using the range of 2004:
US Dollar Index – weekly
Would that be the extent of a potential decline? Not necessarily.
US Dollar Index – monthly
As the big picture chart shows us, there is a significant landing zone not far away, just under the 82 level, however price is likely to overshoot such a mark partricularly since the last time price was at these levels dates back almost a decade. Support and resistance levels have less meaning the farther they are away.
What might be the catalysts for a further and significant drop in the dollar? Would the US actually prefer a soft dollar? There are many opinions and few real answers, as different schools of thought battle for mindshare. Some believe a crisis looms, while others feel a soft-dollar policy, implied or explicit, is just what America needs. Most do agree that a rapid shock to the dollar is, excuse us Martha, not a good thing.
Many Asian countries, particularly Japan and China, are fueling their export industries by supporting the dollar and keeping their own currencies cheap. “How long can they do that? If they begin to have inflation in their own countries, which is getting close in China, they are going to probably have to stop. So we have a pretty unstable world situation… right now,”—Federal Reserve Board Governor Edward Gramlich (Full article)
Many see the burgeoning US Current Account Deficit as a catalyst:
“Former Dallas Fed President Robert McTeer flagged the record $166.2 billion deficit in the United States’ current account, the broadest measure of trade, as a threat to stability. The current account deficit is going to cause problems,” said McTeer, who resigned Nov. 4 from the Fed to run Texas A&M University in College Station, Texas. “Flows will turn against us, and there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar that will be very disruptive,” he said on Oct. 7. (Full article)
In the end, its the chief policy makers here and abroad which pull the levers to make any event happen, so while the debate is interesting to follow, at our level we must contend ourselves with being alert to changes that we can respond to as individuals. And in responding we can ideally make, or protect, a few dollars, along the way.
“Economics is extremely useful as a form of employment for economists.”—John Kenneth Galbraith
The (Yellow Brick) Road Map
We know from long experience that Gold and the US Dollar trade inversely, but not in direct proportion to one another on a percentage basis, so we'll use the trading range built up over the same period of time as the greenback to develop a price target. Using the same Edwards and Magee style price extension used on the Dollar, lets determine a potential target through determining the measured move for the dreaded yellow metal:
Gold – Continuous Futures Contract – weekly
This price extension implies a Gold contract of some $500 or more. Before getting too excited about this, there are a few road blocks that must first be cleared. First and foremost, the current test of top underweigh must pass. Simply put, we want to see old resistance turn into new support.
Should that happen we can all but assume a rapid advance out of the $440 price area will be fueled in part by gold bugs everywhere as cries of “break-out!” are sounded around the world. With co-incidental timing (or not?), a new Gold Exchange Traded Fund (ETF) – the first made available on US markets – will be available next week from State Street Global Advisors which already offer a number of other ETF products under the streetTRACKS brand. (News | Company Web Site)
On the Canadian market, Barclay’s Global has offered the iUnits iGold exchange traded fund (XGD:TSX | iGold web site) for a number of years:
XGD daily
However it trades somewhat sparsely and is clearly not suitable for short term duration “swing trades”. If diversification is your goal, XGD delivers, but its best to use the HUI index, a stock such as PDG, or the weekly chart of XGD to actually time entries.
XGD weekly
Stock Selection
Since fundamentally, Gold producers all perform the same basic function, relative price performance charts can tell us a great deal and help guide our selection.
This chart quite simply explains why my personal favorite has been Placer Dome (PDG:NYSE | PDG:TSX) for some time:
Relative price performance, HUI Gold BUGS Index against selected other gold producers
Recently I’ve started a position in Kinross (KGC:NYSE | K:TSX) as well. It should be noted that ABX and PDG are not part of the HUI index, even though they are third and fifth largest producers in the world. When selecting a stock I do not concern myself with index membership, only raw performance against the common index, so long as the stock has sufficient analyst coverage and average daily trading volume. Both PDG and KGC fully meet this criteria and thus are useful trading proxies to the price of gold.
Conclusion
We’ve laid out the potential for Gold over the intermediate term. From our investigation we know this is a market which can deliver upside potential and we’ve identified an easily observable catalyst – a continually falling US dollar – which can help determine when this market should be pursued on the long side.
Until proven otherwise then, Gold is a market to hunt down new long entries. Over the past two weeks we’ve had at least two solid entry setups in across a broad number of Gold stocks and hopefully subscribers have been exploiting these opportunities. We’ll continue to monitor the complex and highlight for subscribers new entries, potential exit points, and change of trend warning signs when they do finally arrive.
Tools & Information
- A useful Q&A on the US dollar and current account deficits is available from the Guardian newspaper (UK) here.
- The Economist markets and data page includes currency conversion and interactive foreign exchange charting tools.
- Amex Gold BUGS Index – HUI – components list (note that industry majors Placer Dome and Barrick Gold are not among the index components)
- Barclays iUnits iGold web site
- Gold producers ranked by production