You Can Get on the Gold Train and Ride the Dollar

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Includes: DGL, GLD, IAU, UDN, UUP
by: John Micheline

Last Friday, I initiated a position in gold by shorting the Power Shares DB Gold Fund (NYSEARCA:DGL). As I will display, gold usually trades directly opposite the dollar. Consequently, one would believe I have a bullish position in the dollar ... but not exactly. Although I do believe the dollar is going to make a comeback, I am not ready to take a position here. Let me explain.

There were a few reasons floated by the mainstream for gold’s historic rise from $400 an ounce in 2005, to $1000 in 2008. Some of these reasons were valid, others not so much.

First, maybe gold was a little under priced ... maybe. Second, the fall of the dollar caused weary US investors to move money into gold as a natural hedge. Third, global demand is up with the rise of middle class through out the world.

All of these factors may be true, but do they justify gold’s exuberant prices? I don’t think so.

I would argue that some of the price increase must also be attributed to a little mania!

Last week I detailed why oil and oil service stocks were beginning a long term down trend. Today I will show you a long-term bearish trend in Gold and the beginning of a long-term bull trend in the dollar.

(The charts are going to get a little complex, but we'll build up to the really tough ones.)

Let's first take a look at any similarities between gold and the dollar. Below is the 25-year chart of gold and the dollar since 1983. They are almost identical opposites.

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One can see clearly that, as the dollar declines, gold rises and vice versa.

Below is another 25-year chart. I have boxed out periods where the dollar has roared while gold hibernated and vice versa. Notice from 87 - 96 that both traded sideways. During the late 90’s the dollar soared with the economy. As the economy faltered in the new millennium we can see that the dollar's fall coincides with gold’s rise.

Ok, here’s where the charts get a little complicated, but don’t get nervous -- it’s easy. Below, we have a 6-month chart of gold and the dollar. The top indicator is the MACD. In the chart we have 50 and 200-day Exponential Moving Averages (in green, purple and blue). Finally, below the volume indicator we have the (RSI) Relative Strength. Everything else on the chart you do not have to worry about.

Again, over the past 6 months gold and the dollar are trading opposite. In the MACD, notice I circled the bearish signal when MACD crossed its moving average. The EMA shows all three moving averages just crossed over from below the trend line (support) to above the trend line (upward resistance) supporting a bearish trend. Further the 20-day crossed the 50, creating heavy downward pressure. The RSI is also showing a downward trend. The RSI is about 30, constituting oversold territory, meaning we may get a bullish bounce. Nevertheless, we can see the beginning of a bearish long-term trend. (Dollar chart analysis below charts.)

These technical factors mixed with unidentifiable fundamental support of gold’s evaluations leads me to believe that there is significant room on the downside. I just do not believe there is any valid reason for gold’s high prices. "The Chinese like gold" is not a valid argument.

(Above) We are starting to see the start of a long-term bullish trend in the dollar. The MACD has crossed its moving average displaying bullish momentum. The EMA 50 and 20-day have gone from above the dollar (resistance), to below the dollar (support). This newly found support will be the basis of a long-term bullish trend.

You maybe asking yourself, “if I am short gold, why would I not be investing in the dollar with all these technical indicators I am displaying?”

I have two reasons. First, gold and the dollar do not trade inversely 100% of the time, and sometimes there are lag times from one trend to another.

Second, I am not fully confident that the dollar is ready for a huge bull run. Like I have said, I believe gold’s price was artificially inflated on baseless claims and the dollar's fall. You want me to believe demand for gold is up 300% since 92? I do not believe that. Gold is not copper or steel. Gold has no value except jewelry and some industrial parts, but very little. There was no catastrophic invention consuming the world's gold supply. Cars are not going to run on gold.

The free-falling dollar caused nervous investors to look for a safe bet, and they found one in gold. Gold’s rise then created a buying frenzy, which has since slowed (more on this in a bit). A slowing economy mixed with high gas prices are causing consumers to cut back. The exuberant prices for gold are further alienating potential gold consumers. On the other hand, high gold prices are driving exploration and ultimately saturating the market by increasing supply.

The dollar, on the other hand, is down for fundamental reasons. Low interest rates, high debt, saturation of the dollar, a flailing US economy, and so forth. These are real reasons for the dollar's evaluations.

I believe the dollar is about to turn it around, if it hasn’t already. Nevertheless, I am just not ready to jump on board yet. Before I invest in the dollar I want to see some closure in the financial sector and housing market woes. I would also like to see an increase in consumer confidence. When a healthier picture of the US economy can be drawn, then I will be ready to invest in the dollar. I am not concerned with catching the bottom, but I am concerned about making a money-losing mistake.

Here’s how I would play it!

First, short gold.  I purchased the DGL Jan 09, 40 put options [DGLMN] at $8.60.

Below is the 1-year chart of the DGL Gold index. In the first rectangle when gold reached its highest level, the bulls and the bears had a fight. From the outcome we can see the bears won. Then they kept winning these little battles as gold continued to make lower highs through April, May and June. Then a fake rally in July, followed by a continuation of the long term trend. Notice also at gold’s height it was a frenzy, with crazy volume in May. Then slowly but surely gold and the volume continued to decline. It seems to me the buyers are drying up as sellers multiply.

Second, I am watching the dollar for further confirmation of a long-term bull trend. When the right time to buy presents itself I will purchase (NYSEARCA:UUP) Powershares DB US Dollar Bullish Fund.

Below is the 1-year chart of UUP. The dollar opposite of gold is looking good. First look at the volume. In May the volume coincides with heavy pressure on its base level at about 22.5. The bear found heavy resistance at this level over and over again. Every time that level was reached, the volume picked up and the bulls fought off the bear. The heavy volume was a warning shot that the bulls were on their way. In August the volume was heavy again, but this time the bulls broke out through heavy resistance

Still, I will wait for the dollar to build a strong base and continue its breakout pattern. Building the base I believe will take some time. I think the dollar still has some fundamental issues unlike gold that may keep it at this level for a little while longer.

The key with the trades I have been recommending is: don't try to find the top or bottom, but the middle area. The trick is to realize when something is way over or undervalued. Then when the reverse trend presents itself think, “do I believe this position will trade one way or another substantially over the next six months?” If my answer is yes, I will procede either long or short depending on where I believe the momentum is going. I am trying to find the profit in the middle of a bear or bull trend with significant room for profit.

This way I need not worry about top or bottom.

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