THE DOLLAR IS KILLING GOLD, BUT FOR HOW LONG? / SEEKING ALPHA

The Dollar Is Killing Gold, But For How Long?
             

Oct. 7, 2014 4:32 PM ET

 

by: Anthony Fernandez

 

         

 

 

Summary

• The dollar has recently been strong compared to other currencies.     

• This relative dollar strength has lead to gold taking a massive hit.        

• The strength of gold relative to the dollar, has not fundamentally changed, and will eventually triumph.

       

The past few months have been fantastic for those investing in the dollar. Returns have been solidly positive, and other currencies are seeing huge problems (the Yen, especially). While this has been taking place, gold has been hit hard and seen a large decrease over the past few months. I plan to show that this correction is unwarranted and that the strength of the dollar relative to other currencies does not translate to weakness of gold relative to the dollar.

The Historical Relationship Between Gold and the Dollar

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As we can see in the data going back to 1998, the gold spot price and the US Dollar Index show a strong negative correlation. When the dollar rises, gold falls, and vice versa. When the dollar falls, gold sees tremendous gains for the most part. What we have seen since 2012, curiously, is a generally steady US Dollar Index, but gold seriously underperforming relative to historical norms.

The sustainability of this trend is questionable at best, but it is clear that the future of gold depends heavily on the future of the dollar. What is not explained, though, is why gold sees such unwarranted gains when the dollar index sees only modest declines. It is my contention that the strength of the dollar relative to foreign currencies does not dictate fully the price of gold. That is, a debasement of the dollar also must be factored in to explain the outsized gains.

Future Expectations for the US Dollar Index

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The US Dollar Index has been flashing overbought signals since July, and Monday's large loss may be indicative of finally reaching a top. The dollar has done quite well, but these gains have been based on the relative weakness of other currencies, most notably Japan (more on that below). While the dollar has certainly been more stable than these other currencies, we are seeing right now too much of a flight to safety that is inevitably going to turn (and may have already begun to do so).





 

Japan's Involvement

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It is clear looking at this chart that recent dollar strength is due to weakening of the Yen. While Japan is getting hammered, the US Dollar has looked relatively safe. Of course, the money printing in the US has been enormous over the past several years, so we know that compared to what the dollar was before 2008, this current dollar is far less valuable. Still, because of the fact that the dollar index has been rising, gold has been hit hard. This implies that the relative strength of the dollar directs the price of gold, but as I showed before, this alone is not enough to explain gold's price movements. The price of gold in dollars should have only be lightly affected by how the dollar looks relative to other currencies in the long term. This short-term boost of the dollar looks great for now, but the debasement of the dollar will eventually prevail and lead to higher gold prices.

Near-term Gold Expectations

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Gold has been hit especially hard over these past three months, but based on RSI we may be finally experiencing a tipping point. The RSI is indicating oversold, and the gain we saw on Monday may be indicative of a reversal. Yes, the death cross is still there, but I don't think that this will last. US Dollar gains are looking to top right now, and the dollar is incredibly weak relative to gold due to debasement.

Summary and Action to Take

I am still firmly convinced that gold is set to take off in the long term. The dollar has been debased badly, and the base/gold ratio is the highest that it has ever been.

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Anyone investing in the fundamentals of gold over the long term ought to be loading up, as this is potentially the greatest buying opportunity ever seen against the dollar. I am invested in gold bullion and also have long-term call options against Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ). I also own shares of Royal Gold (NASDAQ:RGLD) as they have a nice dividend and are a nearly risk-free way to play the gold market with higher returns than owning gold itself.