Investors have forgotten their history lessons…
Gold prices fell in Tuesday’s trading, on fears of a new and faster spreading strain of the coronavirus in the U.K. Meanwhile, the U.S. dollar strengthened and appears to be poised for a resurgence, which does not bode well for the price of gold in the coming weeks. Is the top in for gold and has the final downward trend begun? Can the U.S. dollar only rise from here?
Gold remains in a downtrend and yesterday it moved to the very upper border of the declining trend channel. It seems that the next move lower can start any day now. In fact, it might have started yesterday.
This is especially the case if the USD Index is about to move higher, and this does seem to be the case, as it moved back above my previous Fibonacci-extension based target.
When the same thing happened in 2018, it meant that the decline was practically over for the USDX, and that the top is in for the precious metals sector.
So, it appears that after bouncing off my initial downside target (89.8 – 90) on Thursday (Dec. 17), the USDX seems poised for a resurgence.
But what are the direct catalysts?
Well, as I already mentioned, the positioning is beyond bearish. And if sentiment reverses, we could see a wave of short-covering (investors have to buy the U.S. dollar to cover their shorts). Last week, USD sentiment hit one of its lowest points in the last 30 years (roughly 11,000 trading days), with negativity only exceeding today’s levels 2.5% of the time.
Please have a look at the chart:
When bearish positioning becomes this crowded, it often ends with a sharp reversal. Focus on the data: Notice how extremes (in either direction) don’t age well?
In addition, traders are ignoring the dichotomy between speculators (those that gamble on currency moves) and commercial traders (hedgers that buy/sell the currency on behalf of actual businesses).
Please look at the following chart:
Please note that commercial traders are actually net-buyers of USD futures. More importantly, the last seven times commercial positioning was this high, it preceded a U.S. dollar rally.
So where is all the negativity coming from?
Well, the narrative from financial pundits includes: 1) QE (money printing). 2) Debt/GDP (fiscal overspending). 3) A climactic debasement of the U.S. dollar.
However, the story is more of a fairy tale.
With liquidity spigots on full blast around the world, the U.S. isn’t the only region expanding its money supply (And remember, currencies trade on a relative basis.) In fact, the European Central Bank (ECB) has more assets on its balance sheet than the U.S. Federal Reserve (FED). All other things being equal (in Economese: ceteris paribus), if things are bad in the U.S. but are worse in other parts of the world, in particular in the Eurozone and in Japan, then the USD Index would likely rally because the USD would seem like a better currency in comparison to the euro and the yen.
Please take a look below:
As of Wednesday (Dec. 16), the ECB has purchased more than $8 trillion in financial assets, while the FED lags behind, at more than $7 trillion. So, while the financial media claims the dollar is being printed into oblivion – on a relative basis, Europe actually takes the cake.
Another important factor is that investors have forgotten their history lessons. Past precedent shows that QE doesn’t debase the U.S. dollar in the really long run. In fact, the greenback actually appreciated (from its early 2008 value) during the first three bouts of money printing (QE1 – QE3).
We are over 10 years after the first QE was announced, after three rounds plus some extra operations, and right now we are in an open-ended QE with the Fed determined to keep providing liquidity as needed. And where is the USD Index? Above its 2008 high.
So …Is this time really different?
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Przemyslaw Radomski, CFA