Is The Greenback In Trouble?

December 25, 2002

Despite mounting opposition to war with Iraq, the Bush Administration is intent upon bringing Saddam "to justice." The resulting rhetoric has dimmed the global community's view of the United States as reflected by the dollar's recent performance. However, a pending conflict is not the only reason dollar parity has deteriorated. Although U.S. corporate scandals are not unique, they have taken center stage in the European community as an indication of our (the U.S.) indifference to corruption. The preacher, as it were, has failed to practice what has been preached.

Subtle hints of isolationism include our move to install a missile defense system in Alaska. The implication is that the C.I.S. remains an enemy. Our "no confidence" vote at the very time Western Europe is relying upon Russia as a new eco-political ally leaves the U.S. out in left field...or completely out of the game. Our unilateral buildup in preparation for war raises questions about our willingness to cooperate with the world community. "We know and you don't," has been the U.S. mantra. We have an attitude problem.

Consider the impact upon the Dollar Index. After establishing a healthful trading range between 10700 and 10950, a lack of faith busted March futures below the 10700 support. Technically, 10700 should provide resistance if we have, in fact, violated the range.

It appears clear that November's rally attempted to reestablish the range. Recall that analysts predicted the Dollar index free fall from more than 12000 in April to 10750 was "overdone." Alleged signs of U.S. economic recovery were supposed to drive the index back above 10700 to a projected 11000/11300.

Anemic U.S. interest rates and stalled corporate performance worked against the November rally. Now, foreign and domestic investors are worrying that the holidays did not produce the spurt needed to encourage a year-end rally in equities or the dollar. The bust below 105 suggests March futures will test parity of 10000 in the near future.

Gold Reflects Lower Dollar Parity

We have not heard much about central bank gold divestiture since the metal has assumed its powerful upward trek. If there were a conspiracy to keep gold's value artificially depressed through central bank selling, it certainly has not materialized. In fact, consider that the Swiss Franc has been quietly leading the pack in a rally against the dollar and has assumed better intra-Europe parity.

The chart looks like a mirror (inverse) image of the dollar index, however, the Swiss Franc gains additional strength from its link to gold.

While currencies were in their trading ranges, gold was posting rising bottoms. February futures were held to a 33000 high, but the technical formation pointed to an upside breakout that we anticipated when placing our buy recommendations at 32200 with a wide stop. Strategically, prices whipped around the 20-day and 40-day averages with significant volatility as illustrated. This fooled traders out of the inherent bull trend.

Yesterday, I appeared on CNBC with Ted David to discuss the potential since gold's dramatic breakout above the 3-prong 33000 February contract tops. It aired at 10:20am Eastern time. As I spoke, gold moved up $3. This could mean people are finally listening. Regardless of talk that mines can't resist hedging or funds are going to take profits, the move higher continues.

A Proxy For Inflation?

In my book, The New Precious Metals Market, I pointed out that gold's greatest purchasing power parity was achieved during the Great Depression... hardly an inflationary period. Of course, since gold was directly linked to the dollar, the relationship was derived from the fact that money deflated. Still, it is the argument that becomes most misunderstood--gold is a de facto representation of purchasing parity.

Thus, gold's increase in purchasing power parity is not currently linked to inflation nor is it a proxy for inflation. It is obvious we have the prerequisites for future inflation that include exceptionally low interest rates, declining dollar parity, rising imports and falling exports, increasing real estate values, rising energy prices, etc. But, the overall inflation is likely to be held in check by static or falling employment, poor corporate performance, belt tightening, and falling consumer spending. Why should gold rise?

As mentioned in my book, gold is a proxy for a confidence crisis. When all else fails, turn to gold. Note that gold's parity has even increased against the Euro Currency as that currency appreciates against the dollar. This signals that investors have more faith in metal (for now) than paper.

The "opportunity costs" of holding gold are very low. What rate of return is sacrificed? One to two percent represents an incidental cost relative to gold's perceived safety and potential stability. How quickly we forget that two years ago, gold was a non-entity! Now, this venerable monetary indicator could crawl its way back onto the front pages of The Wall Street Journal and New York Times business sections.

A further indication of gold's distinctive parity differential is illustrated by overlaying the Japanese Yen (top blue) with the Swiss Franc (bottom green) monthly charts. Notice the distinct divergence from 1999 forward represented by red trend lines.

The yen is not positively correlated to gold as we can see above. The yen rallied with gold from 1986 through 1988 and declined from 1990 through 1994. Keep in mind that gold is priced in dollars. This means that the dollar parity to gold is reflected in the relationship. However, the yen is an inverted image of the dollar. Thus, divergence from the trend shows a negative gold/dollar/yen relationship. This is particularly important to recognize in our current situation. Gold is providing a strong showing regardless of the yen/dollar parity and it is likely the Swiss Franc will have the greatest gold parity correlation because the Franc has been traditionally linked to gold.

More Profit Potentials Ahead

We face a unique situation that brings gold to the forefront after two decades of benign neglect. When returns were roaring out of bonds during the 1980's, gold was the sacrificial lamb because super high interest rates were being used to combat inflation. The wealth effect was ancillary.

When stocks rocketed in the 1990's, gold was ignored because it was a non-income producing asset. Why hold gold as its price declined when you could own stock and watch your wealth grow at double-digit annual rates? Today's economic environment is significantly different. In the words of Bush 41 during his failed bid to recapture the Whitehouse, "Who do you trust?"

A major hindrance to gold's more rapid progress is the public's lack of knowledge and intimacy with the metal. The two-decade decline in gold's luster has left Generation-X devoid of any close familiarity. Even the trailing edge of Baby Boomers was only in college when gold was legalized in 1975. The prior generation needs to go back to 1933 to recall when gold was a physical attraction rather than a symbolic representation of value.

By the same standard, gold has the ability to be rapidly reacquainted with public interest because it can be purchased for a reasonable price per ounce. When you touch it, view it, and hold it, it is hard to resist its intrinsic appeal. Mankind's love affair with gold has been documented back more than 25,000 years according to recent data. It ain't over, yet!


A traditional view states, "What's good for equities is not good for gold." This is based upon the premise that investors never favor safety when stocks appear safe. Generally, I would agree with this axiom. This raises the question about equity values as we move into 2003.

March DOW futures retreated from the December rally and may have formed an elusive head and shoulders with the 8300 neckline I identified as interim support. A number of disappointing news items are simmering which include McDonalds first-ever quarterly loss and Target's drop in holiday sales. Combine these with UAL's demise and rumors that Chase Morgan Stanley is holding billions in derivative exposure...the picture becomes a bit gloomy.

A bust below 8300 signals another interim retreat. Measuring from the head to the neckline, the first objective would be 7600. From there, 7000 would be challenged. According to some experts, a bust below 7000 would be unimaginably bad. Technically, it would pave the way for a test down below 6000. Traditional stock analysis supports a further decline if you accept that P/E ratios remain historically high. In fact, 5,200 is not unrealistic.

The problem with such a decline it that it contracts wealth to the point of depression.

The S&P has a similar formation, however, the right shoulder is less pronounced and the neckline projects a first objective of 790. This remains above the October low. The broader index is less vulnerable. Still, that's a first objective. If the Dow collapses, other indices will follow.

As previously mentioned, I believe the Fed has reached the limit on dropping rates. This means the next move is either static or up. It is doubtful the Fed will tighten in light of continuing weak economic performance and sluggish consumerism. But, the fact that there is no more downside could hold interest rates in check.

The present chart calls for selling 115 calls and 110 puts. The February (based on March futures) 115 calls are 60/64ths and the 110 puts are 40/64ths. January is 37 for calls and 12 for puts. Seasonally, interest rates tend to rise from February into June. This makes the February strangle more risky. The question is whether March notes will breakout 100/64ths above 115 before the February 21 expiration.

Understand that a collapse in stocks will drive investors back to notes and bonds. This is why prices are trading at the upper end of the current channel. Even with an equity meltdown, I don't think notes have the ability to make new highs. Essentially, the market has run out of liquidity. In other words, people don't have money for anything.

Who has money to invest in gold if liquidity is a problem? This is an interesting paradox, however, gold is being controlled by fund buying and a lack of hedging. In addition, entities that borrowed gold to lend at much lower prices are being forced to accumulate tighter supplies... a form of short covering. Don't forget that gold is a small marketplace compared with stocks and government paper. The volume required to drive gold to new highs is a fraction of what it takes to move paper markets.

The Energy Connection

The commodity focus remains oil because it has the most immediate influence upon the economy. As we know, oil has been as exciting as gold. After breaking out above 2800 resistance in the February, I decided it was time to jump as of last Thursday's 2799 close. We were seeking a 30-point decline for an average entry, but Friday's 2743 open was good enough. Once 2800 was breached, prices shot higher as seen on the chart. February crude formed a "V" bottom.

The second resistance was easily overcome at 2950 and we saw some consolidation to suggest this may become interim support. The "V" projects $4 above 2800 former resistance to 3200. The past two days held prices at 3115 which may be close enough.

If February crude tests 2950 and recovers, it is more likely to make 3200. Thereafter, I believe OPEC will consider it "politically incorrect" to encourage a further rally. At that stage (3200) I would be inclined to sell calls to take in some premium.

They say timing is everything. Based upon the U.S. buildup and present rhetoric, there is a strong possibility our conflict will begin next month. January is the ideal time (if there is such a thing) for conducting operations. Weather tends to be most stable and tolerable.

We also took the long side of heating oil Friday morning. The formation is almost identical to crude, however, heating oil has more upside potential in the near term since it takes time to convert crude. A deep freeze in January and/or February could leave us with a squeeze in the February expiration. On the other hand, it would be nice to see an opportunity to see April!


Low pressure raked across the south central causing powerful storms in Arkansas and surrounding areas. This system has moved northeast and will bring rain into the lower Northeast along with milder temperatures through Saturday. The respite from subfreezing temperatures has not impacted heating oil psychology which currently looks forward to a series of cold snaps through March.

A fifty-year study of El Nino suggests that the current higher track for the jet stream can produce a series of freeze/thaws as frigid Canadian air dips south from time to time. The pattern of warm moist air that moves up from the Gulf of Mexico is responsible for unstable conditions like those seen this past week.

High pressure will dominate the west and Midwest. If the Canadian low descends over the weekend, the Northeast could see a White Christmas next week.

From a trading standpoint, I will be watching the March wheat. Any freeze/thaw cycle can be damaging to root systems. In particular, a cycle in February can significantly affect yields. Currently, we have taken a bearish stance with our July/March spread. I am prepared to reverse this next year at the first sign of trouble.

I was concerned that the small rounded bottom in the present consolidation might push prices above 3.65 former support that is now resistance. Fortunately, 3.65 constrained prices and we had a dip below the "U" to suggest further decline.

The March/July spread has come in to about 40¢ March over. One more break should be sufficient to normalize the spread. This would give us a handsome return for a very low-cost position, but we need another bust in March prices.

We continue to hold March corn short with a small loss. Prices remain below the 20-day and 40-day moving average and the overall formation points toward further decline. With an anticipated decline in cattle placements and a drop in export demand, corn can easily test below 2.30. However, I do not expect an appreciable dip below 2.30. Uncertainty over Southern Hemisphere conditions holds this market in suspense above the June 2002 lows.

Soybeans have assumed a sideways consolidation for the same reason. Currently, southern crops have seen some relief. But, the season is young. As commodity traders know, "It's not over until it's in the bin!"

Pure gold is non-toxic when ingested.