THE BULLISH DOLLAR STORY STARTS TO CRUMBLE: WHAT IT MEANS FOR GOLD / KITCO

The Bullish Dollar Story Starts To Crumble: What It Means For Gold

By Kira Brecht, Kitco.com

Friday October 17, 2014 12:00
.

.
Possible disinflation, a taper pause, global growth concerns —the bullish scenario for the U.S. dollar is starting to crumble.

Since the start of the third quarter, the U.S. dollar index surged dramatically higher rallying 7.37% into the October 3 high. Can that be sustained? Not likely. According to a Nomura global markets research note: "Only twice since 1973 have we seen two consecutive quarters of dollar gains higher than 5% (one time from 1980 Q4 to 1981 Q2, and the other from 1984 Q2 to Q3). In fact, following previous quarters of more than 5% gains, the average return has been only 0.7% in the subsequent quarter."

Part of the dollar's outsized rally move in recent weeks has been pricing in expectations of a faster Fed exit from its current historically accommodative monetary policy stance. Carrying that train of thought forward, what would be required to continue the U.S. dollar on a massive rally path? Answer: expectations of even faster and earlier than expected Fed rate hikes in 2015.  In the wake of this week's unexpected comments by St. Louis Fed President James Bullard, who suggested that the central bank should consider delaying the end of the monthly bond purchases, faster rate hikes now appear less likely.

What does this all mean for gold? If the U.S. dollar rally move pauses or corrects, that would provide support for the yellow metal, which is course priced in U.S. dollars. A weaker U.S. currency tends to be commodity-bullish.

Let's take a look at the dollar outlook. Starting with a top down approach, let's look at a monthly chart of the U.S. dollar index, seen in Figure 1 below.  Most significantly, the U.S. dollar index has not eclipsed its post-Lehman high scored in March 2009 at 89.62.




Next let's take a look at the dollar-gold correlation. Figure 2 reveals a daily chart of the U.S. dollar index, with nearby gold futures overlaid in red. An inverse correlation is seen. As the dollar goes up, gold goes down, and vice versa. Technically, the early October low in gold reveals a bullish reversal day which represents a near term bottom for gold prices.



Meanwhile, the U.S. dollar index hit overbought momentum readings in early October (bearish divergences are seen), which has opened the door to a corrective pullback in the greenback. How far could a corrective pullback take the dollar near term? A Fibonacci retracement drawn on the daily U.S. dollar chart off the rally from the July low reveals a 38.2% retracement at 84.07, a 50% retracement at the 83.24 level and a 61.8% retracement at the 82.41 level.

Bottom line? The dollar rally may have run its course for now. The dollar is vulnerable to further unwinding of long positions as traders deprice the probability of a faster than expected Fed rate hikes. The dollar reached overbought levels on its recent run-up and is vulnerable to further downside correction or consolidation from a technical perspective.

With all eyes focused on global growth concerns, gold is likely to benefit from dollar consolidation or weakness in the days and weeks ahead.


All charts: Market-Q