Dollar Countertrend Rally Weighs On Gold

by: Clif Droke

Dollar's recent climb is putting pressure on gold prices.

Eurozone weakness is also adding to metal's short-term weakness.

Improved emerging markets outlook should eventually bail gold out.

A counter-trend rally in the U.S. dollar index is providing a headwind for gold and will likely keep the metal range-bound below its recent high for a few weeks. In today’s report we’ll review the factors which are pushing the greenback higher while temporarily halting gold’s forward progress. I’ll argue here that while March won’t be gold’s month to shine, the metal should be ready for its next leg higher after a much-needed consolidative pause.

Gold’s latest setback was in large part determined by a counter-trend rally in the U.S. dollar index (DXY). As the U.S. and China move closer to a trade agreement, investors have become more optimistic about the U.S. economic outlook. This increased optimism has been primarily reflected in the latest bounce in U.S. Treasury bond yields, as well as the latest DXY rally.

As trade-related optimism increases, global investors are seeing the U.S. as being an ideal place to park investment funds. Hence, the dollar is benefiting from foreign money inflows while the U.S. economy continues to expand. An amicable resolution to the U.S.-China trade dispute would likely provide the U.S. with at least a short-term financial market and economic stimulus, which investors are in the process of discounting.

The dollar’s technical picture has improved in concert with its recent fundamental underpinnings. The dollar index closed on March 1 above its psychologically important 50-day trend line on a weekly basis, which suggests the dollar’s intermediate-term trend may be shifting from neutral to bullish. A breakout above DXY’s closing high for February, at the 97.13 level, would confirm that the dollar’s intermediate-term trend has improved. The most important take away from the dollar’s recent strength, however, is that the gold price will remain under pressure due to its weakening currency component on a short-term basis.

U.S. Dollar Index

Source: BigCharts

Ironically, the dollar’s latest rally came even as President Trump told the press that he favored a weaker dollar. Said Trump:

I want a strong dollar, but I want a dollar that’s going to be great for our country, not a dollar that’s so strong that it is prohibitive for us to be dealing with other nations and taking their business.

Also serving to undermine gold’s short-term outlook is the latest weakness in the euro currency. This weakness is reflected in the Invesco CurrencyShares Euro Currency Trust (FXE), shown below. The euro has been among the worst performing of the world’s major currencies lately and has been hindered by the latest signs of weakness in the eurozone economy. Although sentiment on the eurozone economy bounced slightly in March, according to the latest Sentix economic indicator readings, it still was in the negative at -2.2 points in March, a mild improvement to February’s -3.7 point reading. This showed that there is still room for improvement in the eurozone.

Invesco CurrencyShares Euro Currency Trust

Source: BigCharts

The latest weakness in the euro currency was also blamed on speculation that the European Central Bank (ECB) may implement more stimulus in the eurozone via targeted longer-term refinancing operations (TLTROs). The fact that there is the possibility of economic stimulus only serves to underscore the weakened condition of the region, which is reflected in the lower euro currency and which can act as a drag on gold prices.

Meanwhile on the gold ETF front, the iShares Gold Trust (IAU) was pushed slightly lower on Monday after falling decisively under its 15-day and 50-day moving averages last week. This essentially reversed IAU’s 4-month upward trend and – temporarily at least – gives the gold bears an advantage. I’m waiting for IAU to close two days higher above its 15-day MA, which will confirm an immediate-term (1-4 week) bottom per the rules of my trading discipline. For now, though, a combination of a strengthening dollar and a weak euro outlook is weighing on the gold price. Consequently, I recommend that we remain in a cash position until the latest wave of selling pressure in the gold market has subsided.

iShares Gold Trust

Source: BigCharts

While gold’s short-term picture is currently weak, the latest pullback in the gold price was necessary to shake out weak hands which recently jumped into gold after its 4-month rally. As mentioned in a previous report, I anticipate the gold price will eventually find support somewhere above its 200-day moving average, which is currently at just above the $1,260 level in the April gold futures contract (and at the $12.00 level in the IAU).

Gold’s big-picture outlook remains bullish thanks to an improving outlook for emerging market demand in 2019. However, with the immediate-term trend now no longer supporting a rally, traders should be defensive while longer-term investors should hold off on making new purchases of gold until we have a confirmed bottom in the gold price. A cash position is currently warranted for short-term-oriented participants, as mentioned above.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.