With the FOMC meeting coming up this Wednesday, we are watching the dollar and gold. The dollar index rallied nearly 3% from the late January low on anticipation of higher U.S. rates before profiting-talking at the end of last week on the "news" (or certainty) that the Fed is moving this week. The idea of a negative gold/dollar relationship that many market observers can't shake clearly has not been the case over the last six weeks. The dollar hit a swing low on January 31 just as gold's upside momentum resumed. Gold has fallen back since the end of February while the dollar mini-rally has stagnated. We have been saying for some time that gold's strength has not historically been incompatible with a rising dollar. Gold bulls should not fear a stronger dollar resulting from more aggressive Fed rate hikes. The two reasons to hold gold today are still valid: (1) A hedge against market risk and geopolitical risk and (2) a hedge against the inevitable inflation that the world central bank policy is producing. The election of a U.S. president intent on launching fiscal spending will only accelerate inflation risk and the reasons for holding precious metals. Similarly, Fed tightening is coming too late this cycle (Fed behind the curve, once again) and will not arrest inflation already in the pipeline. The Fed, all too cognizant of the risk of popping the equity bubble with tighter interest rate policy, is sowing the seeds for a very fertile terrain for gold.
On the charts, we are seeing a potential bottom forming in the precious metals complex. While our initial downside objective for gold and the gold miners had been the December 2016 lows, there is a risk that gold bulls waiting on the sidelines may not get to repurchase gold back around $1,120. Our gold chart shows a small bullish hammer candlestick after last Friday's session, similar to the one we saw at the end of January that ended a four-day pullback. Unlike the gold miners, physical gold (NYSEARCA:GLD) is still in a formation of rising tops and rising troughs. We believe that the gold price, as opposed to mining stocks, will give a more reliable signal on the resumption of the precious metals complex.
The gold miners have corrected by a factor of 4x relative to the recent fall in gold. On the chart below, we see that the NYSE Gold Miners Index (NYSEARCA:GDX) has retraced the rally off December lows down to its Fibonacci 61.8% level, a common technical target after sharp moves higher. Given the recent -17% correction in GDX, it may be worthwhile for gold bulls who exited to either retake full positions with a stop at $21 or to start feathering in gradually a new position in the miners. While a retest of $18.50 remains on the table, we expect gold miners to jump quickly whenever market volatility picks up. And in our view, the VIX (NYSEARCA:VXX) index is long overdue for a spike higher.
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