Gold Overcoming Dollar

CPA, Principal & Co-Founder of Zeal LLC
September 16, 2023

Gold has been vexed in recent months by the US dollar soaring again.  Its latest blast higher prematurely truncated a resurging gold upleg again, damaging sector psychology again.  Contrarian traders ought to be familiar with this script of Fed hawkishness goosing the dollar which unleashes big gold-futures selling.  Yet this recurring gold-bearish theme since early 2022 is crumbling, gold is starting to overcome the US dollar.

The last couple months don’t feel like it, as gold plunged 4.5% at worst between mid-July to mid-August.  That killed a promising rally that had just technically confirmed gold’s powerful upleg was resuming.  That month-long pummeling was driven by the benchmark US Dollar Index rocketing up 3.5%, scaring gold-futures speculators into aggressively selling.  Gold did lose ground relative to the dollar during that span.

But while the USDX’s scorching momentum-chasing rally continued, gold defied that and bounced quite substantially.  By last Friday the dollar’s gains had grown to a massive 5.3% in just 1.9 months, enormous for the world reserve currency.  Yet gold’s rebound left it down merely 2.1% in that entire timeframe!  That made for a great show of relative strength versus the dollar, way better than the dividing line of mirrored parity.

When gold falls less than the dollar rallies, it is outperforming.  Gold is overcoming the dollar in these scenarios.  That’s a bullish omen implying speculators are exhausting their gold-futures selling firepower, which is quite finite.  Once these gold-dominating traders’ collective positioning gets excessively bearish, it has to soon mean revert to proportional buying.  That propels gold sharply higher rekindling stalled uplegs.

Much of gold’s volatile price action since the Fed started hiking rates in early 2022 resulted from this interplay between the US dollar’s fortunes and gold-futures trading.  Generally the USDX surged on major economic data that was considered Fed-hawkish, supporting more rate hikes.  Those dollar gains fueled gold-futures selling driving gold lower.  But with this dynamic on its last legs, gold will soon break those shackles.

This chart reveals the opposing gold and USDX price action over the last few years or so, including these last couple months.  The Federal Reserve’s individual federal-funds-rate hikes are superimposed on top, combining for a monster rate-hike cycle.  It was the most extreme this central bank has ever attempted, starting at zero and quickly skyrocketing to multi-decade highs!  The Fed is running out of room to keep hiking.

While gold can’t get any love now, that wasn’t the case before the Fed started hiking in mid-March 2022.  Gold had just soared 18.9% in just 5.3 months to $2,051!  While partially fueled by Russia invading Ukraine, gold was on the verge of achieving new nominal all-time-record highs eclipsing early August 2020’s $2,062.  But with gold very overbought, the Fed’s looming rate-hike cycle started shaking loose selling.

The Fed had held its federal-funds rate at zero since March 2020’s pandemic-lockdown stock panic.  And its maiden hike was only 25 basis points, nothing exciting.  But top Fed officials were predicting a lot more hikes coming, forecasting six more 25bp ones in the rest of 2022!  With inflation raging out of control, the central bankers were starting to panic.  Their speeches and comments pointed to more-aggressive rate hikes.

So currency traders increasingly started pouring into the US dollar anticipating higher coming yields.  The USDX certainly wasn’t low when the Fed started hiking, it had already steadily climbed for over a year.  And gold rallied despite that stronger dollar from early 2021 to early 2022!  While most traders today seem to think gold can’t overcome the dollar, gold has actually surged along with the greenback plenty of times.

But with headline CPI inflation already soaring 7.9% year-over-year, Fed officials were sweating bullets.  They were universally calling for bigger and faster rate hikes leading into the second FOMC meeting after that maiden hike.  So the US Dollar Index started shooting parabolic on that extreme Fed hawkishness!  It was no bluff either, in early May 2022 the FOMC hiked 50bp for the first time since way back in May 2000.

Soon even that was upstaged by a monster 75bp hike at the next meeting in mid-June 2022, the biggest one since November 1994!  The USDX kept skyrocketing on balance as the Fed unleashed four of those huge 75bp hikes in a row.  Just after the third one in late September 2022, the USDX soared way up to an extreme 20.4-year secular high of 114.2!  Everything about that span was extraordinarily unprecedented.

In just 6.2 months, the FOMC had catapulted its federal-funds rate up an incredible 300 basis points!  The FFR hadn’t soared faster since the half-year leading into early 1981, but that started at a far-higher 9.0%.  Last year’s epic rate-hike cycle again launched at zero, making it the most extreme ever.  In about that same 6.0-month span, the USDX rocketed parabolically to an epic 16.7% gain!  That was off-the-charts huge.

The violence of those rate hikes and the resulting dollar rally were shocking.  Gold actually thrived during Fed-rate-hike cycles historically, averaging hefty 29.2% gains during the previous dozen!  But last year’s was so crazy-fast gold melted, plunging 20.9% over a parallel 6.6 months to a deep 2.5-year secular low of $1,623 in late September 2022.  Gold bottomed the very day the USDX’s moonshot ran out of steam.

Gold’s precipitous collapse in the middle of last year did spawn heavy investment selling, and investors have yet to return.  But the main reason gold fell so sharply was extreme gold-futures selling.  With the dollar soaring, speculators aggressively dumped longs and ramped shorts to unsustainable extremes.  Around gold’s bottoming the former fell to a deep 3.6-year low, while the latter soared to a lofty 3.8-year high!

The despair in gold-land was suffocating in September 2022, with traders convinced the yellow metal was doomed to spiral lower indefinitely.  That very month I wrote an essay analyzing why futures still dogging gold had to soon mean revert into proportional buying.  I argued that those crazy-low gold prices were merely “a temporary futures-distorted anomaly, not fundamentally-righteous.”  They couldn’t and wouldn’t last.

I concluded then “The huge gold-futures selling driving them has already been exhausted.  Gold blasted dramatically higher on proportional mean-reversion buying after similar past bearish extremes of spec gold-futures positioning.  That inevitable normalization unfolding again could easily catapult gold 20%+ higher within a few months.”  While I took a lot of flak for that hardcore contrarian call, it soon proved right.

Even though the FOMC kept hiking with another monster 75bp in early November 2022, the radically-overbought exceedingly-euphoric US Dollar Index rolled over hard and started plunging.  That unleashed massive gold-futures buying as speculators scrambled to normalize their excessively-bearish gold bets.  By early February 2023, gold had blasted 20.2% higher in a powerful upleg confirming a new bull market!

Talk about overcoming the US dollar, gold greatly outperformed with that benchmark USDX only plunging 11.3% in that span.  At that point the FOMC had hiked its FFR a colossal 450bp in just 10.6 months, yet gold was still up a modest 1.9% in that cycle despite the US Dollar Index also rallying 2.2%.  But markets don’t move in straight lines for long, and those opposing dollar and gold normalizations were overextended.

The USDX bounced hard in early February after a shocking monthly US jobs report argued for more Fed rate hikes.  The January monthly nonfarm payrolls soared 517k, a statistically-impossible eight-standard-deviation beat to the +187k expected.  Yet that same report claimed 2,505k US jobs were actually lost that month, so a record +3,022k jobs seasonal adjustment was fabricated out of thin air to create that beat!

Coming just days before Biden’s annual State of the Union address to Congress where he took credit for strong jobs growth, that timing was suspicious.  But traders believed that data enough to resume buying US dollars which ignited big gold-futures selling.  Gold plunged 7.2% over the next several weeks or so as the USDX shot up 4.0%.  The yellow metal wasn’t overcoming the greenback then as bearishness exploded.

Does that sound familiar?  Gold gets pummeled lower as a sharp US-dollar surge triggers withering gold-futures selling.  That really damages psychology so traders capitulate and flee, selling low.  That’s pretty much the story of the last couple months too, although gold has proven much more resilient this time around with speculators’ gold-futures selling firepower exhausting.  Fearing dollar strength in February was wrong.

That countertrend dollar surge necessary to rebalance sentiment soon peaked in late February, despite the FOMC going on to hike three more times.  The short-term-overbought USDX still plunged 4.4% from early March to mid-April.  So speculators resumed buying gold futures, forcing shorts to scramble to buy to cover which soon enticed in bigger long-side buying.  Thus gold blasted up 12.4% in that same brief span!

By early May the yellow metal had further advanced to $2,050, again on the verge of challenging new all-time nominal highs.  Decisively achieving those would change everything, working wonders for battered sentiment.  The financial media would really cover new gold records, quickly building awareness and interest.  That would attract speculators and investors in droves, accelerating gold’s upside on big capital inflows.

The FOMC had hiked its FFR ten times, catapulting it an unbelievable 500bp higher off zero in just 13.6 months!  Yet gold was still 6.0% higher over the entire span of that monster rate-hike cycle, despite the USDX’s parallel 2.4% gain.  Gold has proven over and over again historically that there’s no need to fear Fed rate hikes.  So it is endlessly irritating that gold-futures speculators are still so irrationally fixated on them.

But gold was getting very overbought again and due for a breather, while the US dollar was looking more oversold.  So they reversed directions again in May, working off stretched technicals and sentiment in both.  The USDX’s mean-reversion bear market necessary after mid-2022’s parabolic superspike soon resumed, reigniting gold’s big upleg.  It had already grown to +26.2% at best over 7.2 months in early May.

By late June gold’s healthy mid-upleg pullback looked to be bottoming, with the yellow metal down 6.9% in 1.8 months.  The dollar was already losing ground after the USDX had blasted up 3.0% in the last few weeks of May.  I explained why gold’s technicals looked bullish in an early-July essay, gold was starting to rally again as the dollar rolled over hard.  That month’s major economic data was viewed as Fed-dovish.

After an absurd 13 months in a row of Biden-Administration-boosting upside surprises in monthly US jobs, there was finally a miss.  June’s +209k was well behind +240k estimates, along with another -110k of past-month revisions.  Every single monthly jobs report of 2023 has been revised lower, and those initial beats had provided the Fed cover to keep hiking rates.  Then CPI inflation printed cooler than expected as well.

The latest June read in mid-July came in a tenth light in both month-on-month and year-over-year terms, stretching the US disinflation streak to a record-tying 12 consecutive months.  The Fed did hike again as expected in late July, its 11th of this cycle for another 25bp.  But gold stayed strong near $1,974 that day holding on to its resurgent upleg gains.  It had broken out decisively above its 50-day moving average too!

That was important technical confirmation that gold’s powerful upleg was resuming.  Those tantalizing new nominal record highs that would rekindle widespread gold interest were back in sight.  But then an unusual and highly-suspect key economic report temporarily scuttled that rally.  Gold plunged as the USDX surged after a shocking blowout upside surprise in US Q2 GDP, supporting more Fed rate hikes.

The initial read was expected to come in at a +1.8% annualized pace, but the actual proved much better at +2.4%!  Unlike volatile monthly-jobs data, GDP is more even-keeled so significant surprises are quite rare.  That Fed-hawkish report was the trigger for the massive US-dollar buying spawning all the heavy gold-futures selling since.  That started the momentum-chasing trading that dominated these last two months.

Ironically that huge Q2 GDP beat was fake news just like that January jobs report that spawned sharp dollar and gold reversals in early February.  The first revision to Q2 GDP in late August claimed the actual was just +2.1%, which probably wouldn’t have been a big-enough upside surprise to really move both the USDX and gold.  Yet the dollar kept on rallying on momentum buying, fueling more gold-futures selling.

That extended gold’s pullback from early May’s latest upleg interim high to 7.9% by mid-August.  That was similar to February’s 7.2%, after which gold blasted up another 12.4% in just over a month on big mean-reversion gold-futures buying.  Again gold is overcoming the dollar on balance too, only being down 2.1% late last week during a very-strong 5.3% USDX surge.  Odds are these countertrend moves are ending.

The soaring dollar is way overbought and overextended, with traders having excessively-bullish positions in it and excessively-bearish ones in the USDX’s dominant component the euro.  These futures bets will have to normalize and mean revert soon, leading to dollar selling and euro buying.  That will probably be compounded by the Fed running out of room to keep hiking.  This monster rate-hike cycle is over or soon will be.

The FOMC’s last meeting in late July again saw the 11th hike of this cycle taking the federal-funds rate up a colossal total of 525 basis points.  Since the FFR is expressed as a quarter-point target range, that’s 5.38%.  In their latest projections from mid-June, top Fed officials expected the FFR to near 5.63% exiting 2023.  That leaves room for just one more 25bp hike this year, and it likely won’t happen at next week’s meeting.

As of mid-week after this latest CPI inflation report, futures-implied rate-hike odds were a trivial 2% for the late-September FOMC meeting and only 40% for the subsequent early-November one.  While new FFR projections are coming out next week, they probably won’t change much.  Fed officials could even keep mid-June’s forecast of 100bp of rate cuts in 2024.  The Fed probably can’t and won’t hike much more.

The FOMC’s last hike left the FFR at a 22.4-year high, forcing all interest rates in the US economy up proportionally.  They risk destabilizing the US government, which has to pay interest on $32,980b of debt.  At 1% that is $330b per year, but at 5% it balloons to a wildly-unsustainable $1,649b!  The higher the Fed hikes and the longer it holds rates high, the more the government’s interest burden will crowd out other spending.

Americans are hitting a brick wall in consumer spending too, which overwhelmingly drives most of the US economy.  The Fed warns they’ve nearly exhausted their vast excess savings accumulated from all those pandemic-stimulus payments.  Consumer debt to pay for consumption has already exploded too.  And the student-loan moratorium affecting 1/6th of Americans is over, they’ll have to start paying those bills again.

If the Fed keeps hiking while consumer spending slows or shrinks dramatically, that risks forcing a severe recession.  Fed officials don’t want to be responsible for that, especially heading into a big election year where politicians will increasingly attack it.  As currency traders figure out the Fed is done or almost done with this monster rate-hike cycle, the dollar buying on Fed-hawkish data will reverse to mean-reversion selling.

Gold is set up to soar dramatically again as the USDX reverses, much like last spring.  Speculators’ still-excessively-bearish gold-futures positioning guarantees big mean-reversion buying is imminent, which will catapult gold sharply higher.  I detailed all this a couple weeks ago in another essay explaining why gold’s shorting spike is bullish.  Gold ought to take out nominal records this time, great expanding its appeal to traders.

As usual the battered gold stocks have the most to gain as gold’s interrupted upleg resumes again.  The leading GDX gold-stock ETF’s upleg was up 63.9% at best last spring, but averaged far-better 105.4% gains during the last couple huge gold uplegs.  To achieve similar upside this time, GDX would have to power another 56% higher from mid-week levels.  Gold stocks are still very much in the game, ready to soar!

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The bottom line is gold is overcoming the US dollar.  The yellow metal has proven very resilient in these last couple months where the greenback blasted higher again.  That sharp dollar surge is running out of steam, way overextended technically and sentimentally.  Currency traders’ justification for buying on Fed-hawkish economic data portending rate hikes is ending too, with this monster hiking cycle effectively over.

As the bouncing US dollar rolls over into its mounting secular bear again, big gold-futures buying will be unleashed.  That will propel gold sharply higher again as speculators normalize their excessively-bearish bets, buying to cover shorts and adding longs.  Gold achieving new nominal all-time-record highs sooner or later will greatly rekindle investment capital inflows, accelerating this upleg as traders chase gold’s gains.

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Adam Hamilton, CPA, is a principal of Zeal LLC, which he co-founded in early 2000 as a pro-free market, pro-capitalism, and pro-laissez faire contrarian investing and speculating Information Age financial-services company. Hamilton is a lifelong contrarian student of the markets who lives for studying and trading them.


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