Breaking News
Get Actionable Insights with InvestingPro+: Start 7 Day FREE Trial Register here
Investing Pro 0
Ad-Free Version. Upgrade your Investing.com experience. Save up to 40% More details

EUR/USD Tug-Of-War Poised To Affect Gold Prices

By Sunshine Profits (Przemyslaw Radomski, CFA)CommoditiesOct 20, 2021 02:33AM ET
www.investing.com/analysis/eurusd-tugofwar-poised-to-affect-gold-prices-200605631
EUR/USD Tug-Of-War Poised To Affect Gold Prices
By Sunshine Profits (Przemyslaw Radomski, CFA)   |  Oct 20, 2021 02:33AM ET
Saved. See Saved Items.
This article has already been saved in your Saved Items
 

With a tug-of-war for USD Index supremacy unfolding at the 94 level, the PMs are anxiously awaiting the final outcome. And because the EUR/USD is the head of the dollar basket’s snake—due to the fact that the currency pair accounts for nearly 58% of the USD Index’s movement—confusion has arisen over why the euro is strengthening when its fundamental prospects are so weak.

Well, with short-term bursts of optimism par for the course, it’s important to remember that asset prices rarely move in a straight line. Moreover, when analyzed in the context of the EUR/USD’s YTD performance, the recent uptick is largely immaterial.

EUR/USD Daily Chart
EUR/USD Daily Chart

To explain, the candlestick chart above tracks the EUR/USD’s YTD movement. And with each enthusiastic rally eventually thwarted by fundamental realities, euro bulls have suffered mightily in 2021.

More importantly, though, if you analyze the shaded purple box on the bottom half of the chart, you can see that the EUR/USD’s RSI (Relative Strength Index) dipped below 30 (oversold conditions) and triggered a relief rally. Likewise, while similar oversold bounces occurred earlier in 2021, lower lows have plagued the currency pair throughout the year anyway. As a result, the small uptick has done nothing to dent our bearish medium-term (!) fundamental thesis for gold and silver.

To that point, the euro is the third-worst-performing currency within the USD Index YTD. For context, the SEK (not listed below) is the second-worst performer, but the USD/SEK only accounts for 4.2% of the USD Index’s movement.

Currency Pairs Performance Table
Currency Pairs Performance Table

Source: Investing.com

To explain, if you analyze the column above labeled “YTD,” you can see that the EUR/USD has declined by 4.95% in 2021. Moreover, the USD/JPY (13.6% of the USD Index’s movement) holds the top spot, with the currency pair appreciating by 10.73% and implying that the JPY has depreciated by roughly 10% versus the U.S. dollar.

Furthermore, with the Fed poised to announce its taper timeline at its Nov. 2/3 policy meeting, and the ECB running in the opposite direction, a sharp decline in the Fed/ECB ratio should weigh on the EUR/USD over the medium term. For context, the Fed/ECB ratio has already declined by 3.75% in 2021.

To explain, I wrote on Oct. 15:

"The Fed/ECB ratio – which measures the relative money printing of the two central banks – stands at roughly 1.02. And since 2015, if we exclude the EUR/USD’s outlier strength in 2017-2018, when the Fed/ECB ratio sunk below 1, the EUR/USD spent most of its time in the 1.100 to 1.150 range. Moreover, when the Fed/ECB ratio sunk to an all-time low of 0.81 in September 2019, the EUR/USD closed the week at 1.1029."

FED/ECB Ratio Vs EUR/USD
FED/ECB Ratio Vs EUR/USD

To explain, the red line above tracks the EUR/USD, while the green line above tracks the Fed/ECB ratio. If you focus your attention on the left side of the chart, the red arrow depicts when the Fed began reducing its bond-buying program in 2013. Moreover, if you analyze the performance of both variables, you can see that the EUR/USD fell off a cliff soon after and the Fed/ECB ratio plunged after a roughly 12-month delay.

However, unlike in 2013, this time around, the Fed/ECB ratio should decline immediately. And with the ratio likely to fall materially throughout 2022, the EUR/USD (excluding the abnormal strength that we witnessed in 2017-2018) has been unable to record lasting rallies when the ECB is out printing the Fed. As a result, 1.1500 should break over the medium term, and assuming that the Fed/ECB ratio approaches its all-time low, the EUR/USD’s fair value likely lies in the 1.100 to 1.1250 range.

Circling back to the currency pairs’ performance chart, the GBP (11.9% of the USD Index’s movement) and the CAD (9.1% of the USD Index’s movement) have actually strengthened versus the U.S. dollar in 2021. For context, like the USD/JPY, the USD/CAD uses the U.S. dollar as the base currency and a YTD decline means that the Canadian dollar has strengthened.

What Do You Say, Canada?

To that point, while the Bank of England has turned hawkish and potential interest rate hikes put a fundamental floor under the GBP, the CAD is a different story. To explain, Canada is the fourth-largest oil-producing country in the world, and with WTI gunning for its ninth-straight week of weekly gains, rising oil prices have uplifted the Canadian dollar.

Top 10 Largest Oil Producers
Top 10 Largest Oil Producers

Source: the U.S. Energy Information Administration (EIA)

Conversely, while crude’s fervor is bullish for the Canadian dollar and bearish for the USD/CAD, a continuation of the theme is mutually exclusive to the Fed’s 2% inflation goal.

To explain, I wrote on Sept. 30:

"Powell’s only hope to curb inflation is to strengthen the U.S. dollar and weaken commodity prices. For context, major futures contracts are priced in U.S. dollars. And when the dollar rallies, it’s more expensive for foreign buyers (in their currency) to purchase the underlying commodities. As a result, a stronger U.S. dollar often stifles demand. And with the current supply/demand dynamics favoring higher commodity prices, Powell will have to work his magic, strengthen the dollar and reduce commodities demand if he wants his inflation problem to subside."

USD/CAD vs WTI
USD/CAD vs WTI

The green line above tracks the USD/CAD, while the red line above tracks the inverted WTI futures price. For context, inverted means that the latter’s scale is flipped upside down, and that a rising red line represents falling crude prices, while a falling red line represents rising crude prices. If you analyze the relationship, you can see that a stronger USD/CAD often stifles WTI’s bull markets.

To that point, if you focus your attention on the three red arrows, you can see that when the WTI rallied alongside the USD/CAD, the divergences ended with crude oil reversing sharply within three to nine months. As a result, with the Fed no longer ‘all in’ on “transitory” and a November taper announcement likely a done deal, the central bank needs the green line to rise to help calm the inflationary pressures. Thus, with a stronger USD/CAD poised to help Powell achieve his goal, his days of talking down the U.S. dollar are likely over.

As further evidence, the chart below demonstrates how the entire commodities complex makes a living off of a weaker U.S. dollar.

USD Index Vs S&P GSCI
USD Index Vs S&P GSCI

The green line above tracks the USD Index, while the red line above tracks the inverted S&P Goldman Sachs Commodity Index (S&P GSI). For context, the S&P GSCI contains 24 commodities from all sectors: six energy products, five industrial metals, eight agricultural products, three livestock products, and two precious metals. However, energy accounts for roughly 54% of the index’s movement.

If you analyze the relationship, you can see that a stronger USD Index often curbs commodity inflation. And while the S&P GSCI has surged in recent weeks, even as the USD Index has strengthened, the relationship has stood the test of time—the sharp rally (plunge) in the USD Index (S&P GSCI) in 2014-2015 is a cautionary tale of how quickly things can change.

The bottom line? If Powell allows the U.S. dollar to weaken, his inflationary problem will only intensify. Thus, not only does the greenback have technicals, fundamentals, and sentiment (speculative futures positioning) on its side, but the Fed will likely become the U.S. dollar’s staunchest ally. And unless Fed officials want to see 6% and 7% year-over-year prints on the headline Consumer Price Index (CPI), their days of playing ‘PMs up, USD Index down’ are likely over.

In conclusion, the PMs traded in the red on Oct. 18 as U.S. Treasury yields rallied across much of the curve. And while the EUR/USD has strengthened in recent days, lower lows should still materialize over the medium term. Moreover, with the Fed’s taper announcement likely to commence in the coming weeks, the forthcoming liquidity drain is fundamentally bullish for the U.S. dollar. And with the PMs often moving in the opposite direction, a stronger greenback will likely weigh on the PMs’ performance over the next few months.

EUR/USD Tug-Of-War Poised To Affect Gold Prices
 

Related Articles

EUR/USD Tug-Of-War Poised To Affect Gold Prices

Add a Comment

Comment Guidelines

We encourage you to use comments to engage with other users, share your perspective and ask questions of authors and each other. However, in order to maintain the high level of discourse we’ve all come to value and expect, please keep the following criteria in mind:  

  •            Enrich the conversation, don’t trash it.

  •           Stay focused and on track. Only post material that’s relevant to the topic being discussed. 

  •           Be respectful. Even negative opinions can be framed positively and diplomatically. Avoid profanity, slander or personal attacks directed at an author or another user. Racism, sexism and other forms of discrimination will not be tolerated.

  • Use standard writing style. Include punctuation and upper and lower cases. Comments that are written in all caps and contain excessive use of symbols will be removed.
  • NOTE: Spam and/or promotional messages and comments containing links will be removed. Phone numbers, email addresses, links to personal or business websites, Skype/Telegram/WhatsApp etc. addresses (including links to groups) will also be removed; self-promotional material or business-related solicitations or PR (ie, contact me for signals/advice etc.), and/or any other comment that contains personal contact specifcs or advertising will be removed as well. In addition, any of the above-mentioned violations may result in suspension of your account.
  • Doxxing. We do not allow any sharing of private or personal contact or other information about any individual or organization. This will result in immediate suspension of the commentor and his or her account.
  • Don’t monopolize the conversation. We appreciate passion and conviction, but we also strongly believe in giving everyone a chance to air their point of view. Therefore, in addition to civil interaction, we expect commenters to offer their opinions succinctly and thoughtfully, but not so repeatedly that others are annoyed or offended. If we receive complaints about individuals who take over a thread or forum, we reserve the right to ban them from the site, without recourse.
  • Only English comments will be allowed.

Perpetrators of spam or abuse will be deleted from the site and prohibited from future registration at Investing.com’s discretion.

Write your thoughts here
 
Are you sure you want to delete this chart?
 
Post
Post also to:
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Thanks for your comment. Please note that all comments are pending until approved by our moderators. It may therefore take some time before it appears on our website.
Comments (3)
Mr Doodl
Mr Doodl Oct 20, 2021 4:29PM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Really interesting that CAD is outperforming USD despite USDs strength.
Sonia Jain
Sonia Jain Oct 20, 2021 5:12AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
Interesting and imformative as always ✨
Sonia Jain
Sonia Jain Oct 20, 2021 5:12AM ET
Saved. See Saved Items.
This comment has already been saved in your Saved Items
👍🏻✨👍🏻
 
Are you sure you want to delete this chart?
 
Post
 
Replace the attached chart with a new chart ?
1000
Your ability to comment is currently suspended due to negative user reports. Your status will be reviewed by our moderators.
Please wait a minute before you try to comment again.
Add Chart to Comment
Confirm Block

Are you sure you want to block %USER_NAME%?

By doing so, you and %USER_NAME% will not be able to see any of each other's Investing.com's posts.

%USER_NAME% was successfully added to your Block List

Since you’ve just unblocked this person, you must wait 48 hours before renewing the block.

Report this comment

I feel that this comment is:

Comment flagged

Thank You!

Your report has been sent to our moderators for review
Continue with Google
or
Sign up with Email