Gold, Oil and the Dollar

The U.S. dollar index has broken through the major 75.00 support zone over the past few sessions, which puts the 74.00 target area in play. The lower U.S. dollar price action shown against the majors in trade this week is driven by a higher stock market and, to some degree, commodity trading that seems to be more concerned with long-gold in response to a weaker dollar than it does as a fear of inflation.

There is no real evidence of heavy inflationary pressure to match the tone set by those calling for inflation-backed gold trades. Since March 2009 the gold market has added around 20%, compared to the 50-60% moves that equities have made. If anything, the natural balance of equities trading lower as gold trades higher would be expected if the inflationary based outlook was in play.

When real inflationary pressure hit during the 1970’s, gold hit all-time highs and was counter-balanced by negative equity outlooks. At that time the dollar was revalued, the gold standard was scrapped and the global banking system for developed economies switched from hard assets to paper assets. The same quantum leaps in asset valuation may be happening right now, in a big-picture view that has many near-term pieces to fit together.

In near-term trades we can therefore expect gold and equities to become aligned, as central bank liquidity floats all asset prices, except for the one used as the global currency, the dollar. Looking to equities, we can see that S&P futures have broken through the 1098 area, which may be the reason for more dollars weakens to come, as gold is also higher, with current levels just below the $1120 area. (That is an awful lot of dollar bills to hold a tiny ounce of metal).

Interestingly, oil is still trading below the $82 per barrel mark, with prices trapped in a technical triangle formation. Triangle formations are continuation patterns, so once the upper side of the triangle line in a bull market, or lower triangle line in a bear market, is broken, a very powerful move usually appears.

The real variable here, and a possible explanation of why oil has not climbed in-line with recent equity and gold strength and USD weakness, is supply and demand. Back to the inflation-or-not argument; without global growth that turns to expansion, the demand side of the supply chain has clogged the pipes in regard to price action.

The speculative interest is obviously not concerned about higher forward global growth figures, if they were the oil markets would be tracking the previously correlated markets.

TheLFB Charting: Triangle

On the left side of the chart, we can see one of the most common fourth wave triangle formations that comes in a bull market. On the right side is shown a structure that appears in a bear market.

The triangle legs are labeled as a, b, c, d and e, where none of these legs should exceed the top or bottom of the previous legs for a valid formation. Once the final leg of the triangle, (wave e) is complete, the market breaks through the major triangle line, which is the key for a powerful move towards the new highs or lows.

Oil prices have been bullish for the last ten months, in a reaction to the stimulus-effect that raised all asset classes, and as such the triangle on the chart below is placed in the middle of the bull market, around the major $80.00 a barrel level.

TheLFB Charting: Oil 4 Hour Elliot Wave view

“The triangles usually appear in very important areas, where the price calms down before the major level is taken out. As such, traders may see a move higher through the 82.00 area over the coming days, and the triangle may be completed soon”, said Grega Horvat, Senior Currency Strategist at TheLFB.

Recently, the wave d leg was completed around the upper triangle line, which means that the final triangle leg, wave e, is in progress. If this is the case then the short wave e leg should find support somewhere above the critical 76.47 area for a valid wave count formation.

Once wave e completes, a move towards the 82 resistance area should follow, where a break-out will put the 84.00 target in play.

Traders may see more U.S. dollar weakness against the majors if this oil play triggers long, because right now, the only one of the major asset classes that is not inside the dollar-bashing party, is oil.

If this plays out, the dollar index may hit the March 2008 lows, and that is where sovereign wealth funds, petro-dollar economies and overseas central bankers stepped in to heavily reverse things from 72.00, and soon after the reversal of oil prices from record highs began.

Comments

[montyman:]

Actually, the reversal of record oil prices started after July of 2008, not March of 2008.

And are you sure that those sovereign wealth funds, etc., will be able to step in so easily again? You make it sound like reversing the dollar weakness is trivial.

Nov 11 11:30 PM

[The LFB:]

In the article we state "and soon after the reversal of oil prices from record highs began." understanding the lag effect of dollar values in the correlation to oil.

There is nothing trivial at all in reversing the dollar values, especially when so many dollars are held in reserve across the globe, and petro-dollar and fiat currencies rely upon it. Trading is following the law of probability, and looking for the pattern that went before to once again happen again.

The dollar reversed from these levels previously, and there is nothing to say that will not happen again. Fiscal deficits and budget explosions, do not take away from the fact that the dollar has two sides to it; internal U.S. use that is comfortable with it being weak, and international use in commodity and reserve values. There is nothing trivial about it at all, and putting the options aside, there is every reason to think that the dollar will gain in strength in the near-term.

Thank you for the feed-back.

Nov 12 07:04 AM

[The shark:]

Hi thank you for some well articulated insights.

My comment would be as follows:

Over the past 6-7 months the markets have tended to be pivotal on the USD. It therefore appears that ,market behaviour across all asset classes are behaving with remarkable inter-connectivity. This applies even to the HUI and in particular GOLD - the latter historically more a contrarian vis-a-vis the Equity market.

If this is correct then if OIL is about to thrust from it's triangle then we must assume continued market strength and continued USD weakness? However, to me it appears that the markets are very choppy with what appears to be a move away from the more "risky" shares (note Financial's and the none confirmation of the S&P over the past 2 weeks) to the more Blue Chip shares of the DOW. Also on Thursday we saw the USD trying to make a move up - albeit tentative it is the first time in a while that the USD has looked even close to a move up. All signs of a potential reversal in my opinion are starting to fall into place. Lastly, the EW have over the past two months been unreliable presenting many "fake tops".

Obviously this is a bigger topic of discussion - but what if the Institutional "leverage" from those "popping the market" whenever we see "dips" are starting to gradually withdraw their "bankrolls" - do technicals / historical trends still have value - or are we now in uncharted waters where everything and anything is possible - and it becomes a lottery in defining broader trends?

Nov 13 06:58 AM