The dollar is moving toward a crossroads. The U.S. Dollar Index, which tracks the buck against a handful of the world’s major currencies, has been consolidating along an uptrend line that began in December 2004, but also along a downtrend that started in November 2005. Given that the trendlines are on path to intersect, the dollar will be breaking out soon. Technically speaking, it looks very likely that the direction will be to the downside.
With China and other countries freely talking of plans to diversify their foreign exchange reserves, which have been predominantly comprised of U.S. dollars, the FX hordes now have a fundamental excuse to push for a breakdown.
After the turn of the millennium, the White House told us a strong dollar was in our best interest, but it was pretty obvious that they didn’t really mean it. The dollar index, which tracks the U.S currrency against a basket of its major trading partners, lost a third of its value from the February 2002 high (120.51) to the December 2004 low (80.39), but the government did nothing to fight it.
The Street.Com reports that "gold is still glittering" and the shine is about to get much brighter.
Traditionally, the demise of the dollar is what sends investors scurrying for an asset class that will retain its value even in the face of rampant inflation. During the late 1970s and early 1980s, for example, rising oil prices sparked double-digit inflation in the U.S. The result was a flight to gold that ultimately pushed the price to a record high of $875 an ounce in January 1980...
The greenback rebounded in 2005, yet has resumed its downward slide so far in 2006 as the government continues to borrow — and print — money to pay for things like Hurricane Katrina relief and the Iraq war. Gold has not exactly traced the path of the dollar this year because widespread speculation has created a more volatile environment, but the links between the dollar, inflation and the shiny metal still apply.
Technicals Indicating Dollar Breakdown
The technicals aren’t looking very good for the dollar. Looking at the short-term chart, we can see that the dollar recently broke down, crashing through the 50-day and 100-day moving averages. These lines, which traditionally act as support , provided no such thing. In fact, the dollar continued falling and broke the trend line that has been in place since August. We have also highlighted the fact that the MACD displayed a bearish crossover and shows no sign of recovering. The RSI has also been hovering around 40 for the first time since the start of August. Momentum is clearly moving against the dollar in the short term. Let’s take a look at the short-term chart.
Looking back a bit further, we can see that the dollar staged an impressive rally in the six months from May to November of 2005. But it quickly gave back these gains, sinking all the way back to 84 is one month from April to May of 2006. It has since been consolidating and forming a descending triangle, which is the precursor to a breakout. Unfortunately for the dollar, we agree with The Street’s assessment that the breakout will be to the downside. But technicals are just one piece of the puzzle when analyzing the dollar’s decline.
Fundamentals Also Pointing Towards Dollar Breakdown
A number of countries, including Sweden, the United Arab Emirates, Qatar, India and Russia have all announced intentions this year to diversify their reserves away from dollars. China’s reserves alone have topped $1 trillion, doubling from 2004! U.S. dollars are thought to account for over 70% of this amount.
How significant is this figure and what does it mean to gold?
Well, it would be enough to buy all the gold sitting in central banks’ vaults twice over. Put another way, if China invested just 5% of its reserves in gold, it could buy the world’s entire annual mine production. If China decides to take this route, those wild predictions about $2,000 gold could come to fruition in a hurry. Are you still sitting on the sidelines thinking gold is a barbaric relic?
Fan Gang, director of China’s National Economic Research Institute and member of China’s monetary policy committee, went on the offensive as recently as November 11th, stating that the world's real problem today is an overvalued dollar, not only against the renminbi but against all major currencies. He added that "the main responsibility for this imbalance lies with the US Treasury, which is printing too much money".
Zhou Xiaochuan, governor of the People’s Bank of China, added insult to injury by bluntly stating that China was “considering lots of instruments” to diversify its foreign exchange reserves.
Additional downward pressure is being exerted on the dollar by the US’s $80bn reserves, which is roughly the value of the US Treasury bonds maturing and coupon payments due on November 15. It is estimated that foreign investors would probably be receiving about 40 per cent of those payments.
Summary: Dollar Breakdown to Ignite Gold Market
We expect the next few months to be very good for gold and silver investors. We have been adding to our positions over the past week and will continue to do so in the coming few weeks. We have posted several articles about the gold stocks we like and silver stocks we like, but this is just our opinion and should not be taken for investment advice. Please perform your own due diligence before investing. We will post a summary of the returns of our stock picks at the end of this year.