The Temporarily Strengthening Dollar and What This Means For Gold

The U.S. Dollar Index has made a sharp reversal higher, breaking through its 50 day moving average (blue line in Chart 1) for the first time in 9 months. If the index holds above this critical technical level, we will see an unraveling of the carry trade in stocks and commodities. Now while we believe that the long term trend for the dollar is down, in the short run we could see upward reversals such as these. It is also important to note that trends once established in the currency markets, usually persist for some time.

Chart 1: U.S. Dollar Index

The dollar's push higher comes as foreign central banks temporarily overtake Bernanke's printing press. Recall that while Bernanke's quantitative easing is set to "expire" in March, Japan just announced a $81 billion stimulus coupled with Bank of Japan's offer to pump more money into the economy via $110bn in low interest loans. In addition the Euro has been trading lower as Fitch downgraded Greece's credit ratings, from A- to BBB+, in response to a huge public deficit. Note that unlike the U.S., European nations that fall under the Euro currency umbrella, do not have the option to unilaterally print their way out of this problem. The European Central bank must decide whether it wants to print Euros to help out member countries and traditionally Europeans have been very wary of running up the printing press. Memories of the German hyperinflation are still fresh in their minds.

So What Does This Move Portend for Gold?
Chart 2: Gold Prices

As we have stated in our previous posts gold could correct if the dollar carry trade unwinds. However any such correction would be in the context of the long term secular bull market in gold remaining intact. As long as government's keep the printing press on, gold is a superior asset to hold over paper currencies. To date all indications point to governments choosing the easy printing press way out. So we will look for any significant corrections as an opportunity to add to our existing bullion positions. A look at gold prices in Chart 2, indicates that prices are approaching their 50 day moving average (blue line) of $1,097. The key would be for this average to hold, otherwise if gold breaks below the 50 day moving average, look for a deeper correction.