To reinforce their opinion, they produce one chart after another with their cycles, or cross rates, or Elliot Wave this or that wave, T-Bill yield, or some other such thing. The initial impression that one is left with after reading their musings and observing their artwork is that these sure are clever fellows who have some amazing methods of correlating data and coming up with some nifty looking charts. Of course, the usual effect is to instill more fear, doubt and uncertainty in the minds of the would-be gold bulls to the point where if I had to make a guess I would say that many who entered the gold arena last year have already thrown in the towel and are back to listening to CNBC and chasing tech stocks.
The question which one ought to ask however when surveying this motley collection of prophets is: "Can they make any money with this stuff or does it just make pretty pictures on a page and sell newsletters?" After all, that ought to be the final arbiter of things, should it not?
It is this issue which I wish to address therefore in particular. One of the things I have learned over my many years of trading for a living is that pundits come and go and their predictions come and go with them. The only constant is the market itself and it, and it alone, is the final judge of who is right and who is wrong. The trader who wishes to profit soon learns to tune everything and everyone out and rely on the market to inform his or her judgment. The simple truth is that NO ONE knows the exact future for if they did, they would possess something which mere mortals are incapable of doing. The best we can do is to attempt to divine the future by extrapolating from the past. Please keep that in mind anytime you read predictions they are merely the opinion of one man over against someone else and one man's guess is as good as another's.
Now back to the issue at hand. Below please find a Weekly chart of the U.S. Dollar going back to 1995. As you can see by examining the chart, the dollar moved up from a low near the 80 level and proceeded to enter a bull market that last nearly seven years peaking near 121 in July 2001 and then again in January 2002. From that last date the dollar has given up the entire move in a period of three years moving back down to the 80 level in late December 2004. Suffice it to say that what comes up eventually comes down but that the rate of the dollar's descent has even surprised some dollar bears.
Having laid out the dollar's price action over the last ten years, let us now turn our attention to the indicator at the top of the chart; the RSI or Relative Strength Indicator. This particular indicator has been time tested and is usually included in just about any basic technical analysis charting software package. For that reason I have chosen to use it and it alone to refute the predictions of those who are telling us that the dollar has turned the corner and is about to embark on a period of prolonged strength.
If you will notice the RSI panel you will see that I have drawn several dashed horizontal lines at various levels of the indicator. The levels are 25, 40, 60, 65 and 70. These are essential to understanding what I am about to explain so please note them well.
Typically, the RSI is used as a price oscillator where levels below 20-25 are considered oversold, and levels about 70-80 are considered overbought. The basic way of using the indicator, in the minds of many, is to sell whenever the RSI rises above 70-80, and then buy when the indicator drops below 20-25. Sometimes that will work; sometimes it will not. The point I really like to convey is how to use the indicator to determine whether a market is in a bull phase or in a bear phase or simply neutral.
Notice the period from 1995 to mid 1997 on the dollar panel and then observe the corresponding readings on the RSI panel. You will observe that during that entire time period, the RSI reading never dipped below the 40 level. Many weeks found it near the 70 level, one time exceeding that and running all the way to near 85 in 1997. This kind of action by the RSI is a clear signal that the dollar was in a bull market and that dips were eagerly being bought. The fact that it could not break below the 40 level was a sign of inherent strength.
The first sign of a chink in the armor occurred with the classic divergence pattern seen in 1997 where the dollar went on to make a new high but the RSI could not exceed its previous level. From that point on, each successive rally in the Dollar was accompanied by a lower peak on the RSI. In April 1998, the RSI could barely muster a reading above the 60 level in spite of the fact that it went on to make new highs. This was a clear warning signal that market internals were deteriorating. Indeed, in August 1998, the dollar dropped precipitously from 102.82 to 90.74 in October 1998. The resultant decline sent the RSI crashing through the 40 level for the first time in more than three years. To a technician this was a sign that the bull market in the dollar was temporarily derailed. The test was soon to be seen a few months later when the dollar moved back up breaking through the 60 level and continuing to head up to near the 70 level once again.
Here is what is critical to grasp. In a bear market, the RSI will tend to peak on short covering rallies near the 60-65 level and then head back down to near the 30 level and lower. In other words, RSI levels will tend to oscillate between 20-25 or lower on the oversold level and 60-65 on the overbought level. Should a market breach the upper end and move above the 60-65 level on a short covering rally, that is a signal that there is more strength in the market than the trader may have anticipated and as a result, he or she should be very careful and re-evaluate their position.
The exact opposite is true in a bull market. The RSI will tend to move between the 40 level on the bottom or oversold level and 70 or above on the overbought level. Should the market break down and the RSI drop below the 40 level, traders should re-evaluate their view as the market is showing signs of inherent weakness and perhaps transitioning from a bull to bear phase.
Notice that the reaction setback that occurred in mid 1999 sent the RSI back to the 40 level but this time it did not break that level. For the next 2 ½ years, the RSI did not go back below the 40 level. Translation - the dollar was back in a bull market having shrugged off its bout of weakness in late 1998. Look at how much time the RSI spent above the 75 level in the year 2000.
In spite of that stellar performance, once again cracks were appearing. Late 2000 witnessed a mild divergence that gave rise to a setback in price into early 2001. The 40 level held nonetheless confirming the bullish stance and the market rebounded reaching the 121 level in July 2001. However, in so doing, a serious divergence appeared. What is more noteworthy however is that the RSI failed to exceed the 65 level during this rally in which it went on to make new highs. Clearly, this market was becoming weak internally.
From that new high in July 2001, the dollar set back once again holding the 40 level on the RSI in September 2001 before rebounding. The bulls were still in charge even though they had been given a good scare. Notice however that the rally into early 2002 clearly was the bull's last gasp. The market once again could not muster the strength to take the RSI over the 65 level and on up to the 70 level or above. It was running out of steam.
In hindsight, 2002 turned out to be the bull's last hurrah. The breach of the 40 level on the RSI in April 2002 revealed that the tide had turned and that the market was entering a bearish phase. The question was would it turn out to be a repeat of late 1998 and early 1999 when the dollar would come roaring back to defy those who had predicted its demise? Alas, 'twas not to be. Notice that since that time period in 2002, NOT ONCE has the dollar been able to muster any sort of short covering rally that has been capable of driving the RSI above the 60 level. NOT ONCE! As a matter of fact, it has struggled since to reach the 55 level before being rudely turned back and hurled unceremoniously down toward the nether regions near 20-25 on the RSI.
This most current rally has seen the dollar reach the 45 level thus far. Should it be turned back here, it will only be a repetition of what we have seen so far in the last three years. Even if it goes on to rally further, the onus is on the would-be dollar bulls to prove that the rally is for real.
The summary of all that has been said thus far can be stated as such - Until and unless the dollar can mount a sustained rally that drives the RSI above the 60-65 level and on up to the 70 level on the weekly chart, it is in a BEAR MARKET, declarations of 'soothsayers' and 'prophets' and 'pundits' notwithstanding. Should that occur, I will be the first to admit that there has been a sea change in market opinion concerning the dollar. Until it does, let traders safely ignore the self-anointed scribblers and tea leaf readers. You do not need them; the market will tell you what to do.
As a side note, apply what I have just stated above to the following weekly gold chart where I give you a long term look that includes gold in both a bear market and a bull market and see if you can put two and two together.
Dan Norcini
February 3, 2005
Dan is a professional off-the-floor commodity trader residing in Texas and can be reached at dnorcini@earthlink.net with comments.