Euro Negatively Correlates With Gold As Dollar Takes A Breather

Volume has not been as light as expected in this holiday week of trading though the markets have performed about as expected as the S&P floated higher today even though the dollar nearly broke even after a late day rally. The sovereign debt crisis in the EU has been making headlines as I predicted in January and has been the driver behind the weakness in the equity markets and the catalyst for the recent rally in the dollar index. Notably, the strong Euro, strong gold correlation has broken down as it did one year ago when we were in a similar situation in the financial markets. As we know, typically the dollar slips on Euro strength which in turn gives gold and commodities a lift as they negatively correlate with the dollar index. However, as of late, gold has rallied along with the dollar as a safe haven asset versus the uncertainty regarding EU nations like Greece and Portugal. This too is something that I predicted would happen a few months ago. See “The Dollar Index Vs. Gold And Commodites” for reference, and more recently, “Is There An Across The Board Reversal Around The Corner?” where I called the bottom in the dollar and the top in the Euro and silver days before it took place.

On Monday I talked about the 100 MA being a critical support level for many of the major asset classes including the S&P. The trendline going back to November coincides with the 100 MA which is where the S&P found support today and on Monday as well. The 50 MA was tested and rejected during today’s trading and ultimately I think that the 100 MA has to break as the market is poised to move lower. However, there are two reasons why I believe that it will not break that trend this week. One is that people are going on vacation starting tomorrow and Friday which bodes well for the market as POMO has a greater effect on the market when volume is light. The other is that we have just traded into the lower level of a price channel that started one month ago and momentum and volume are not substantial enough to cause a break of that trend yet. We have only tested the 50 MA as resistance once and I think one more small rally is in order before the market gains enough momentum to lose the 130-137 on the SPY.

The dollar has pulled back of off Monday’s gap higher which is typical after a large move as holders of the asset will take profits to lock in gains. Breakouts are almost always followed by immediate consolidation patterns such as a flag or a pennant which are minor moves to the downside that stay within the range of the breakout. UUP is building up a bull flag on the daily chart after the big move on Monday. It looks as if it will pull back to about $21.65 which was Friday’s closing price and about where the 13 Day MA is headed. If it does this, it will complete a support trendline that is currently in progress. Given the fact that it is forming a bull flag, I am inclined to believe that this support trend will hold. Also worth mentioning is the volume that has been noticeably weak during negative days on this chart which is in contrast with the positive trading days that have all been backed with two to three times the daily volume. In short, this rally isn’t at all ready to quit yet and the next stop after this should be the 100 MA.

Negatively correlating with the dollar is the Euro. It has fallen as expected and though commodities have rallied, it has merely limped neutral to positive when assets such as gold have moved significantly higher which suggests that the positive correlation that these assets share is at least for now, breaking down. While gold has broken out of a short term double top, the Euro has been choppy and if anything, the last three days of trading are starting to look like a bear flag, though in this particular case, the candles are very loose and more “in the spirit” of a bear flag as opposed to being a textbook chart pattern.

Gold has managed to break through a short term double top that went back to the second week of the month. Though it has closed above this level twice, it still hasn’t quite confirmed a breakout as it hasn’t tested $148 as support and today’s close was still negative which leaves questions about how much momentum it has. Regardless, it still appears to be strong especially compared to the rest of the market as it is usually not breaking out to new highs whenever the dollar is rallying. I’ve talked about this recently, but gold is the ultimate safe haven asset. We are in a time where currencies are being rapidly devalued and debt may soon be restructured. Certainly there is a lot of deflation risk as well, but even some of the perma-bears have recommended gold due to the fact that currencies may need revaluation and holding Dollar, Pounds, Yen, Euros, etc. may not be safe as all potential outcomes regarding currencies appear to be catastrophic. During a wide scale default, even if the default is deflationary, there is still currency risk which is a large part of the reason why I think gold is so attractive here.

To sum up my sentiment on the subject, I’d rather take my chances going into a wide scale default and/pr inflationary crisis with an asset that has been used as money for 5,000 years than a declared currency that can be changed or manipulated by bureaucrats and academics in government.

Moving on, I’m less bullish on silver than I am gold though silver has also shown some strength during the latest round of European sovereign debt issues. Silver has rallied significantly for the last three days but the chart is telling me to be cautious and that this may be a fool’s rally. There are several reasons to list – the 50 MA has flatlined, volume has been dead during this rally, it was due for a bounce off of the 100 MA and to straighten out the MACD, and finally, despite a 14% rally in the last three days, it is still well within a three week trading range and should find double top like resistance just above $38 (on SLV).

As I stated before, if you are looking to protect yourself from currency and sovereign debt concerns, buy gold instead. Gold is the preservation of wealth and silver is the money maker but I do no see capitulation in silver yet which is why I will not become full-on bullish unless something else happens to change my mind.

Ultimately, we should expect the dollar to continue to gain ground against the Euro though it’s not clear to me if the positive correlation between the Euro and commodities is ready to permanently breakdown here. If it is, then we may be on the verge of many major decoupling events on a global scale that could make for a new norm, or perhaps other implications of which the ends cannot be predicted. On the other hand, this correlation breakdown could be temporary like it was a year ago which would mean that in a month or two, the dollar would continue its long term downtrend assuming QE 3 is announced or some other inflationary policy takes place, or, the dollar continues to rally and commodities and the Euro slide in the face of deflation. For now, I am playing the market from the long side of the dollar until I am convinced that these trends are ready to reverse once again.

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About Aaron Basile
Market Technician, Equity/Commodity Trader, Austrian Economist, Contrarian Investor

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