Buying Opportunity Brewing For Gold, Silver As U.S. Dollar Picks Up Steam

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Includes: GG, GLD, PAAS, SLV, UDN, UUP
by: Duru

The U.S. dollar confirmed yet again the importance of its 200-day moving average (DMA).

I updated my review of this case two weeks ago by demonstrating in detail how the dollar sustains moves both above and below its 200DMA. In this current move, the dollar stretched for three days above the 200DMA, fell back for three days, and then bounced away from the 200DMA on the way to 7-month highs.

This is a “good enough” test of the 200DMA as support and produces a foundation for an extended rally (click to enlarge images):

U.S. dollar rallies to fresh 7-month highs after a successful test of support at the 200DMA

U.S. dollar rallies to fresh 7-month highs after a successful test of support at the 200DMA

Source: FreeStockCharts.com

Previously, I made the case that the fundamental support for a dollar rally is that alternative “safety” valves have become relatively very expensive. Everywhere the scared turn, they find serious drawbacks:

  • The yen is already at historic highs against major currencies and the Japanese have made it clear they want to weaken their currency.
  • The Swiss have punished safety-seekers by enforcing a peg against the euro which plunged the franc from historic highs.
  • Rates on 10-year Treasury bills are at historic lows even though this debt has been downgraded by Standard & Poor’s. Moreover, doubts grow over the ability of the U.S. to summon the collective political will to cooperate on dealing with its debt and the economy.

With this backdrop, safety in the form of cash-money U.S. dollars looks extremely cheap with the dollar index hovering just above multi-decade lows (of course, ironically enough, some large portion of U.S. dollars that the scared collect will be “stored” in the form of Treasurys). The dollar was further helped by last week’s monetary policy statement from the Federal Reserve which did not include any new news of currency debasement. The Fed is just moving money from one investment (short-term bonds) to another (long-term bonds). Moreover, three board members objected to additional policy accommodation thus creating an unfamiliar (relatively) hawkish encampment in the Fed.

And then there is gold.

The dollar’s recent gains have delivered much pain to gold. Gold has fallen 8% in three days and is 13% off its all-time high set earlier this month. Gold’s rise year-after-year has been greeted with increased skepticism and even derision. Every pullback has been celebrated as a “told you so” moment by the gold skeptics that the yellow metal has been floating on bubbles after all. New highs have not brought increased enthusiasm. Indeed, enthusiasm for gold continues to wane.

A long-term chart reminds us of both the source of the skepticism and the reality of gold’s enduring strength. After the Fed moved to fight inflation and then gold tanked in 1980, gold settled into an average price of $400 over the next 16 years. It even declined going into the year 2000.

I can thus sympathize with anyone concluding at the time that gold was a dead currency. The recovery back to the $400 average took another four years, so it was easy to miss that a rally was underway. Within four more years, gold doubled. It doubled again in three more years. And in 2011, gold seems to have shot straight up. Who wants to buy into such highs, right?

Gold has recently gone parabolic but long-term trend remains well intact

Gold has recently gone parabolic but long-term trend remains well intact

Source: World Gold Council – prices through Sep 16, 2011

A chart with a logarithmic scale gives better perspective. Here, one can see that gold has followed a steady trend upward since the 2000-2001 lows. While the “collapse” in gold during the 2008 panic seemed gut-wrenching at the time, over the longer haul the move represented a mere return to the trend – see the lower green line below.

Depending on your perspective, the rally since the 2008 lows has established a new upward trend. In 2011, gold has peeled far from even that trend. A return to trend should not surprise anyone. This observation means that $1600 or so represents the first opportunity to buy gold. A move back to the primary trend line would occur around $1300 and that level would deliver the second good buying opportunity.

Gold closed Friday at $1640. I will be happy to add to my holdings in gold, including gold miner Goldcorp (NYSE:GG), as I still feel very under-invested.

Gold has followed a relatively steady and stable trend since the 2000-2001 lows

Gold has followed a relatively steady and stable trend since the 2000-2001 lows

Source: World Gold Council – prices through Sep 16, 2011

So what about silver? Silver has fared even worse than gold in the current correction. Silver is now down 35% from the highs it set in April. Silver has fallen 23% in two days including a one-day collapse of 13% on Friday. Silver sliced right through what had appeared to be support around $34.

Silver "crashes"

Silver "crashes"

Source: StockCharts.com

The buying opportunity is a little harder to gauge in silver, including in silver miners like Pan American Silver (NASDAQ:PAAS), especially since it is more economically sensitive than gold. One potential gauge is the gold-to-silver ratio. During silver’s strong run starting last summer, silver far outpaced gold. That out-performance came to a screeching halt in April and gold has come back on silver in a few sporadic spurts. I am thinking the first opportunity to buy silver may be when the gold-to-silver ratio returns to recent averages, starting at 60 and perhaps going as high as 75.

Gold is coming back against silver

Gold is coming back against silver

Source: StockCharts.com

In the meantime, I expect gold and silver to trade in volatile spurts both up and down. Fear is a funny beast. Those who bought gold and/or silver out of fear will be very confused since none of their fears have gone away (ballooning U.S. debt, European sovereign debt crisis, recession, threat of Depression, etc..) even as silver and gold decline. (For my last discussion on gold as the fear trade see “If Gold Is Going Higher on Fear, It Is Fear of Greenspan“). This confusion should lead to a violent tug of war of buying and selling. Those who are simply speculating to follow momentum should add further fireworks to the volatility as momentum appears to swing up and down in rapid fashion.

For the calmer set eying trends and central banks, the buying opportunities are as clear as the continued desire and intent of financial authorities in the major economies to manipulate their currencies lower for economic advantage (or maybe as clear as their own rush to add to gold reserves). For example, the Federal Reserve is not likely to “allow” the U.S. dollar to rally too far while it applies accomodative monetary policies that seek to keep BOTH short-term and long-term interest rates at rock bottom levels for the next two years. The Bank of England appears ready to launch another round of quantitative easing. Even the European Central Bank may be forced to send rates lower to address its own economic problems. Finally, we already know about the desires of the Swiss and the Japanese to chase away all who seek shelter under their currencies.

The only currency that cannot be printed at will and without limit is gold (and silver).

Be careful out there!

Disclosure: I am long GLD, SLV, GG, PAAS. I am also net long the U.S. dollar and Swiss franc, and short the yen.