Is The Dollar About To Lose Grip On Commodities And Gold?

The story in the markets since last year has been undoubtedly the crash of the oil price (-50% in six months) and the monstrous rally of the U.S. dollar (+25% in the same period of time).

Putting the recent U.S. dollar uptrend in perspective provides some interesting insights. During the second half of the 90ies there was a similar rally in the dollar which pushed commodities and significantly lower; that appeared to be of relatively short duration, however, even in the wake of a continuation of the dollar rally.

The very long term U.S. dollar chart provides three interesting insights from a chart point of view. First, the steepness of the recent rise is quite unusual. Second, the dollar is currently severely overbought, as measured by the RSI momentum indicator. In fact, it has not been in such an overbought condition in the last 3 decades. Third, and foremost, the dollar is entering an area which should provide strong resistance. That area is indicated with the red rectangle on the chart.

Obviously there is no guarantee that the dollar will not break through 100, nor is the chart telling us anything about the further upward power. It tells us that an intermediate term correction should be near, and that the recent rally has been exceptional, diminishing the probability that it will continue at the same pace longer term.

The rally of the greenback has put a lot of pressure on commodities, crude oil being the major victim. The million dollar question is how much more downside there is given a continuation of the upward trajectory of the dollar.

We analyzed a similar period of exceptional strength in the U.S. dollar. During the 1997 – 2000 timeframe, the dollar index went up from 85 to 119, as expressed by the green dotted line on the next chart. Mind the blue rectangle which displays a very strong trending move, starting in November 1996 and producing an intermediate peak in the summer of 1997. That was followed by a consolidation period of more than 2 years and a continued upleg into 2000.

The chart discloses the dynamics between the U.S. dollar, U.S. stocks (light red line) and gold (yellow line). The key take-away is that the dollar was able to push commodities and gold meaningfully lower during its first trending move in 1997. However, during its consolidation period and its second upleg, there was no similar pressure on gold anymore while commodities rallied along with the dollar. The stock market kept on trending higher, and corrected only slightly in 1998.

If history can serve as a guide, we should expect a decreasing grip of the dollar on commodities complex and gold. The first leg of the dollar's rally is able to produce a meaningful impact on commodities and gold, but that power fades during the consolidation phase and the second upleg.

Fast forward to today, gold and commodities are running into a very strong, multiyear support area. That happens to coincide with the dollar running into strong, multiyear resistance during its first upleg.

Does it mean that gold and commodities cannot go lower? No, that is not the right conclusion. The dollar can surely go higher, but it will take a rest in the foreseeable future. Likewise, gold and commodities are near structural support, implying that the downside is limited.

Going forward, all this will result in opportunities for investors. Our belief is that the metals will continue their uptrend at some point in the future. Timing the trend change is impossible to predict. Moreover, a select number of resource companies are about to outperform their peers. It requires a lot of study to uncover the stars in this market, but the rewards of those select companies could be astonishing on the long run.

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Courtesy of http://goldsilverworlds.com/