Low US Dollar Risky for Gold / Commodities / Gold & Silver 2020

Today’s beaten-down USdollar is a major short-term risk for gold. For decades this yellow metal has often inversely mirrored the fortunesof the world’s reserve currency.  Dollartrends are important trading cues for highly-leveraged gold-futuresspeculators, who wield outsized influence over gold prices.  So an overdue mean-reversion rebound rally eruptingin the US dollar will unleash serious gold selling pressure.

Gold has proven the ultimateuniversal global money for millennia now, and its US-dollar price Americanspeculators and investors follow is simply these currencies’ exchange rate.  So flowing and ebbing dollar levels directlyimpact prevailing gold prices.  Goldgenerally tends to rally when the dollar weakens, then sell off when itstrengthens again.  The leading dollar benchmarkreveals this powerful inverse correlation.

That is the venerable USDollar Index, which was launched way back in March 1973.  This USDX applies a weighted geometric meanto a basket of major world currencies to track the relative value of the USdollar.  The Eurozone countries’ euro, Japan’syen, and the United Kingdom’s pound sterling dominate the USDX commanding 57.6%,13.6%, and 11.9% of its total weighting. Three other currencies round it out.

The USDX’s sometimes-domineeringinfluence over gold prices has faded off traders’ radars in recent years.  That’s because gold and the US dollar ralliedsimultaneously through most of 2019, leading many to assume that dollar-goldlink was broken.  But it merely wentdormant, taking a back seat to another big gold driver.  Gold was powering higher on massive inflows ofstock-market capital through major gold ETFs.

The overwhelmingly-dominantones are the GLD SPDR Gold Shares and IAU iShares Gold Trust.  Just over a month ago I wrote a comprehensiveessay analyzing this critical gold-movingdynamic.  In times when stock-marketcapital is deluging into gold, this metal can indeed decouple from the USdollar because stock traders don’t care about it.  They chase gold upside momentum,fueling virtuous circles of buying.

But much of the timestock traders aren’t frenziedly shunting vast amounts of money into gold viathose major-gold-ETF conduits.  In thesemore-normal conditions, speculators’ gold-futures trading dominates gold’s priceaction.  The incredibly-dangerousleverage extremes these guys run force them to myopically trade very-short-termtime horizons.  Nothing motivates them tobuy or sell gold futures more than dollar swings.

This first charts provesgold’s longstanding opposition to the US dollar’s fortunes remains alive andwell.  It superimposes gold’s priceaction during this secular bull over the US Dollar Index’s own along with someof its key technicals.  Despite episodeswhen big differential gold-ETF-share buying worked to overwhelm and suppressthe classic dollar-gold relationship, it has still greatly influenced this overallgold bull.

All secular bull marketsare an alternating series of uplegs followed by corrections.  This current gold bull has enjoyed four majoruplegs and suffered three major corrections. And its fourth correction is underway today.  That makes for eight separate bull segments sofar, which are separated here by vertical red lines.  In fully 7/8ths of these segments covering thelarge majority of this gold bull, gold inversely mirrored the USDX.

That happened to varyingdegrees, depending on how much capital stock traders were pumping into or out ofphysical gold bullion through those big gold ETFs.  But major gold uplegs coincided with US DollarIndex downlegs, and major gold corrections unfolded on USDX reboundrallies.  That’s why the current low US dollaris a serious short-term threat to gold.  The USDX slumped to a 2.3-year low in late August.

But this year’s volatileUS-dollar action began during mid-March’s brutal stock panic.  That was spawned by governments’ draconiannational lockdowns to attempt to slow the spread of COVID-19.  Those fueled tremendous fear, traders hadnever seen anything like that.  As stock marketsplummeted, there was a stampede for the exits and a mad dash for cash.  Save-haven US-dollar demand explodesduring stock panics!

Before that uglystock-market selloff cascaded into a full-blown panic, which is a 20%+plummeting in two weeks or less, gold climbed to $1675 in early March.  Not coincidentally that was the same day theUSDX bottomed after plunging 4.9% over 12 trading days.  Then as the stock selling intensified and theFed panicked slamming rates back to zero, the oversold USDX rocketed higher ina stratospheric spike.

The red lines abovesegment gold uplegs and corrections, which don’t always precisely matchthe days the dollar tops and bottoms. But over the next 8 trading days as the USDX skyrocketed a stupendous8.1% higher, gold cratered a horrendous 12.1%! When the US dollar is surging, gold-futures speculators rush to dumptheir long positions and pile on to the selling momentum with new shorts crushinggold.

While compressed into alightspeed-fast timeframe, that third correction of this gold bull had the samestrong-dollar driver as the first two. Back in late 2016, the first correction saw gold plunge 17.3% over 5.3 monthspartially on a sharp 7.1% USDX rally. That catapulted this leading US-dollar benchmark to a lofty 14.0-year secularhigh!  Gold’s second correction sharedthis same catalyst of a big-and-fast US-dollar surge.

In roughly the first halfof 2018, gold plunged 13.6% over 6.7 months on a sharp 8.2% USDX rally.  A much-stronger US dollar has proven a seriousshort-term threat to gold during this bull, and remains one today.  Those three earlier gold corrections averaged14.3% losses over 4.1 months, which cascaded on the USDX soaring a tight average7.8%.  Those are mighty rallies by glacially-slowcurrency standards!

After its epic 2020-stock-panicsurge, the US dollar was extremely overbought. So it immediately rolled over into a major downleg.  That combined with huge differential gold-ETF-sharedemand is the reason gold was able to soar 40.0% higher over the next 4.6months.  Had the stock-panic-goosed USDX notcollapsed 9.6%, gold’s last major upleg would’ve been much smaller.  The US dollar’s fortunes still drive gold.

The USDX’s plummeting lastsummer was driven by heavily-crowded short selling in this world’s reservecurrency.  Professional traders piled onto the dollar-collapse bandwagon.  Notonly had the Fed slashed rates to zero killing yields in dollar-denominated USTreasuries, but US-government debt was soaring on trillions of dollars ofpandemic-stimulus spending.  So dumpingthe US dollar became fashionable and popular.

Gold started shootingparabolic in late July, soaring a colossal 13.5% higher in less than several weeks!  Extreme gold-ETF-share buying was the primary driver.  But also boostinggold was the USDX’s sharp 3.2% plunge over that same short span.  Gold peaked at $2062 in early August the sameday that this dollar benchmark slammed into its initial interim low.  The next day’s dollar bounce kicked off gold’sselloff.

The former wasshort-lived, as the USDX soon tumbled to even-lower lows in late August.  But with gold sentiment euphoric and gold technicals extraordinarily overbought, the stronger dollar had already done itsdamage.  With gold’s upside momentum broken,the big differential gold-ETF-share buying in GLD and IAU mostly dried up.  Gold consolidated high as the USDX drifted, thenresumed selling off as the dollar bounced.

At worst by lateSeptember, gold’s selloff extended to 9.8% nearing formal correction territory startingat 10%.  During that 1.6-month span, theUSDX merely climbed 1.7%.  But if youlook at higher-resolution daily charts of gold and the US dollar since earlyAugust, these competing world currencies are almost moving in perfectly-opposedlockstep.  As during this bull’s pastcorrections, gold is back at the mercy of the dollar.

Unfortunately that isreally bearish for gold over the near-term. The battered and heavily-shorted USDX is still way down near majorsecular lows.  That implies it has a lot more mean-reversion rallying left to do, fueled by both short-coveringbuying and momentum-chasing long buying. And any sustained US-dollar uptrend will force gold into a deepercorrection more in line with its bull precedent.  That’s a big risk for gold!

One way to quantify theUS Dollar Index’s short-term upside potential is looking at where it has tradedrelative to its 200-day moving average during past gold corrections.  Dividing the USDX’s daily close by its 200dmayields the Relative USDX or rUSDX.  Thatis based on the same RelativityTrading principles I analyzedfor gold in another essay a month ago. How high was the rUSDX when past gold corrections ended?

This gold bull’s firstthree corrections finally bottomed at rUSDX levels of 1.071x, 1.044x, and 1.049x.  These average out to the US Dollar Index surgingto 5.5% above its 200dma.  Dollar mean-reversionrallies after major selloffs usually don’t end until considerably over that key technical baseline.  But thehighest the rUSDX has been since late August’s US dollar secular low is merely0.974x in late September!

At best this leading US-dollarbenchmark was still 2.6% under its 200dma, which is a far cry from thatgold-correction-ending 5.5% over.  And sincethe USDX has retreated again as of the middle of this week, it is back down to3.6% under or a 0.964x rUSDX.  The hammeredUS dollar has much farther to bounce yet before it mean reverts highenough to rebalance away oversold technicals and still-bearish sentiment.

Mean-reversion reboundsfueled by short covering don’t necessarily need a catalytic driver, but thereare still plenty of potential ones for the USDX today.  In recent weeks the US dollar has rallied insolid up days whenever the perceived odds wane of the US Congress agreeing onanother big round of pandemic-stimulus spending.  That moderates the ballistic trajectory of USdebt growth, making the dollar look stabler.

The upcoming US-electionresults could fuel major dollar buying. They could change the way currency traders are gaming the likelihood of anotherbig debt-financed government-spending binge. They could ignite stock-market selling fueling safe-haven demand for theUS dollar.  And remember that over4/7ths of the USDX’s weighting is in the euro alone!  So European events hitting the high eurocould drive dollar buying.

The European CentralBank could force its rates even deeper into negative territory, or unleash vastnew quantitative-easing bond monetizations weakening that currency.  The Eurozone’s economic outlook could darken,making the US look relatively more attractive. COVID-19 infection rates in Europe could keep resurging, leading to morenational-lockdown threats from those countries’ governments.  Lots could happen.

Only time will tell howhigh the USDX’s overdue mean-reversion rebound rally will climb, but precedent suggests big dollar gains are likely.  Thisgold bull’s past-few-corrections average rUSDX level of 1.055x when theybottomed implies a lofty 102.2 USDX based on its current 200dma this week.  That is a huge 9.4% higher from today’sdollar levels, and would make for a total USDX rally of 10.9%!  But I don’t expect that.

In recent years theUSDX hasn’t soared back up over 102 without major surprises, including Trump’s stunningpresidential victory four years ago and this year’s ultra-rare stock panic.  Those shocks helped pull up the USDX’saverage rally of 7.8% during this gold bull’s corrections.  That average would imply a USDX toppingaround 99.4, 6.4% above this week’s levels and making for a 7.8% total mean reversion.

The bare-minimum USDXrally gold traders should look for is a 200dma approach, which is waysmaller than gold-bull precedent.  The USDX’s200dma is running 96.9 in the middle of this week, though it continues to fallwith the dollar so pummeled.  Mean revertingback up to that 200dma now would require the USDX to surge another 3.7%,bringing its total rally off late-August lows to 5.1%.  That’s troubling for gold.

Even this lowballed really-conservativedollar-bounce estimate suggests nearly 3/4ths of the dollar’s gains arestill coming!  And gold has behaved verypoorly on recent bigger USDX up days.  Gold’ssharp 1.9%, 2.2%, 1.5%, and 1.6% daily plunges that happened on September 21st,September 23rd, October 6th, and October 13th were driven by larger 0.7%, 0.4%,0.3%, and 0.5% USDX up days!  They are areal threat.

The reason isspeculators’ current gold-futures positioning.  These traders are still largely betting onmore near-term gold upside, their outlook is quite bullish.  So if the USDX surges, they have vast amountsof gold-futures contracts they will need to sell fast to shift their capital outof harm’s way.  The crazy leverageinherent in gold-futures trading makes it exceedingly unforgiving.  These guys can’t afford to be wrong for long.

Each gold-futurescontract controls 100 troy ounces of gold, which is worth $190,000 at $1900gold.  Yet the margin requirements forbuying or selling each contract are only running $10,500.  That’s the amount of cash traders have to keepin their accounts.  Thus traders canlegally trade gold via futures at extreme 18.1x leverage!  At that level a 5.5% gold-price move againstfutures bets would wipe out 100% of capital risked.

So if the USDX continuesmean reverting higher and pressuring gold, major selling will be unleashed ingold futures exacerbating gold’s correction.  This next chart shows specs’ total long andshort contracts as reported weekly in the famous Commitments of Tradersreports.  Gold is superimposed on top,and specs’ total gold-futures buying and selling during each of this gold bull’suplegs and corrections are noted.

Compared to when thisgold bull’s prior corrections bottomed, spec longs are still high and specshorts are still low.  In the latest-reportedCoT week before this essay was published, which ended on Tuesday October 6th,total spec longs and shorts were running 387.4k and 99.0k contracts.  As their green and red lines ominously reveal, big selling is still necessary before positioning nears prior gold-correction-endinglevels.

As this gold bull’sfirst several corrections gave up their ghosts, total spec longs were running275.8k, 258.2k, and 368.7k contracts.  Thatthird correction during March 2020’s stock panic was high since that selloffwas so blisteringly fast.  But thesestill average 300.9k contracts, which is 86.5k lower from currentlevels.  That much selling is the equivalentof 269.0 metric tons of gold, a big slug that would crush gold lower.

Total spec shorts wererunning 126.0k, 250.8k, and 67.0k when this gold bull’s earlier correctionsended, averaging 147.9k.  Specs wouldhave to short sell another 48.9k contracts to get back up there, which is theequivalent of another 152.1t of gold.  Sogold now faces a menacing gold-futures-selling overhang exceeding 421t!  That’s a lot of selling that could cascade ifa stronger dollar scares these guys into fleeing.

Even if thisoversold-USDX mean-reversion rally was the only near-term downside risk goldfaced, it is certainly serious enough to demand caution.  All of this gold bull’s prior correctionswere driven by these periodic dollar surges, and today’s fourth one likely won’tprove any different.  But that’s not theonly big short-term risk factor plaguing gold. A couple of my recent essays analyzed some other ones to keep in mind.

This gold bull’s fourthcorrection likely hasn’t run its course yet, with gold overboughtness lingering and sentiment remaining way too bullish for a major bottoming.  And the huge differential gold-ETF-sharebuying that catapulted gold’s last upleg higher has gone missing in action sinceupside momentum failed.  As dollar-drivengold-futures selling forces gold lower, resulting big gold-ETF selling could amplifythe downside.

Today’s low US dollar,which remains oversold and riddled with excessive popular bearishness, is justone of several big near-term risk factors for gold.  So odds are there will be more selling tocome in this gold correction.  Thatimplies better buy-relatively-low opportunities are still coming in gold, silver,and the stocks of their miners.  The majorgold stocks in particular tend to amplify gold corrections by 2x to 3x.

Both speculators andinvestors should embrace these inevitable rebalancing corrections, as theyyield the best mid-bull buying opportunities within ongoing bullmarkets.  That is when to aggressivelyredeploy in gold, gold ETFs, gold-stock ETFs, and individual gold stocks with superiorfundamentals.  Bulls’ inexorable upleg-correctioncycles are great boons for traders, greatly expanding their potential gains tobe won!

At Zeal we started aggressivelybuying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows.  We layered into dozens of new positionsbefore gold stocks grew too overbought, which were stopped out later at hugerealized gains running as high as +199%!  Our subscribers multiplied their wealth withinmonths.

To profitably trade high-potentialgold stocks, you need to stay informed about what’s driving gold.  Our popular newsletters are a great way, easyto read and affordable.  They draw on my vastexperience, knowledge, wisdom, and ongoing research to explain what’s going on inthe markets, why, and how to trade them with specific stocks.  Subscribe today and take advantageof our 20%-off sale!  Correctionsare the time to do your gold-stock homework, preparing to redeploy as they pass.

The bottom line is today’slow US-dollar levels are a serious near-term risk for gold.  After the dollar’s past big selloffs, it hassurged sharply higher in major mean-reversion rallies.  When those unfolded during this secular goldbull, the yellow metal suffered major corrections.  A rapidly-strengthening US dollar forcesgold-futures speculators to aggressively dump their leveraged positions, whichfuels snowballing gold selling.

With the US dollar sooversold and bearishness on it so universal, there are all kinds of potentialcatalysts to drive its overdue mean-reversion rally.  They could come from the dollar side based onhow pandemic stimulus and upcoming US elections play out.  But economic weakness or health crises inEurope could also hit the euro boosting the US dollar.  Gold remains at risk of further selling untilthe dollar normalizes.

Adam Hamilton, CPA

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