In Wednesday’s analysis, I focused on the specific situation in the currency market and its impact on the gold price. I told you that the USD Index was probably forming a short-term top, while the Euro Index was forming a short-term low. But I also wrote that despite their usual link, this time, the decline in the USDX could actually make the gold price move lower, not higher. And that’s exactly what we saw Thursday. Specifically, I wrote the following:
“Bullish” or “bearish” refers to the future, not the past. In fact, the rally in the USD Index might need a breather as all markets—no matter how bullish or bearish they are—can’t rise or decline in a straight line without periodic corrections. The USD Index, gold, silver, mining stocks, and practically all the other markets are no exception to this rule. Even real estate prices don’t increase in the long run without periodic downturns.
As you can see on the chart above, the U.S. currency index soared to almost 96 Thursday, and that was after an almost straight-up rally. That rally caused the RSI indicator to move above 70, which has been a quite precise short-term sell signal this year. In fact, in all the cases when we saw it, some kind of short-term correction followed.
Based on the size of the current rally, the current situation seems very similar to that of early March and late June. Back then, we saw short-term declines that took the USDX approximately a full index point lower. In the current case, this could mean a decline back to 95. This would be a perfectly natural thing for the USD Index to do right now, as the previous resistance (which is now serving as support) is located slightly below 95. The support is provided by the late-2020 high and the March 2020 low (not visible in the chart above).
“So, surely this corrective downswing in the USD Index would cause an even bigger rally in the precious metals sector, right?”
This is where things get complicated.
You see, the biggest (over 50%) part of the USD Index (which is a weighted average) is the EUR/USD currency pair. Let’s take a look at it.
The Euro Index has dropped significantly over the past week and just as the RSI based on the USD Index flashed a sell signal, the RSI based on the Euro Index flashed a buy signal.
Also, the Euro Index just moved to the lower border of its declining trade channel, which is likely to indicate some kind of rebound.
Why am I discussing the euro here? Because that’s what’s complicated about the current USD-gold link.
The euro has recently declined and the prices of silver and gold have rallied shortly after the dovish comments from the eurozone. Namely, while the expansionary nature of fiscal and monetary policy decisions in the U.S. might be after its peak (with the infrastructure bill signed even despite high inflation numbers), the eurozone is far from limiting its expansionary (i.e. inflationary) policies and it has been made clear recently.
That was bearish for the euro and bullish for the gold price – as more money (in this case euros) would be chasing the same amount of physical gold bars.
The point here is that it might have been the decline in the value of the European currency that caused gold to rally, and it had little to do with what happened in the USD Index.
Don’t get me wrong, most of the time, the gold-USD link is stable and negative. In some cases, gold shows strength or weakness by refusing to move in line (and precisely: again) with the U.S. dollar’s movement. But in this case, it seems that it’s not about the U.S. dollar at all (or mostly), but rather about what happened in the eurozone and euro recently.
I marked the recent decline in the euro and the rally in gold with a golden rectangle.
The usual link between gold and USD would make one assume that lower USD Index values (due to higher EUR/USD values) would trigger a gold rally. However, given how things worked and the fact that we saw/heard the news coming from the Eurozone, it seems like this “temporary” and bearish for the PMs interpretation would actually prevail. It could also be the case that we see some kind of mixed reply from the precious metals sector when the USD Index and the Euro Index correct. The PMs could for example fall only after the situation regarding gold-USD link gets back to normal, that is perhaps after both currencies have corrected.
This is exactly what happened Thursday. The Euro Index moved higher, the USD Index moved lower, and gold—instead of soaring—declined.
The USD Index ended the day 0.29 lower and gold declined by $8.80. That happened right after gold failed to break above its declining red resistance line. In other words, it seems quite likely that the top is in.
The RSI indicator was just close to 70, which is something that we usually see at the major tops. The sell signal from the Stochastic indicator confirms the bearish outlook as well.
Gold bulls likely expected that based on USD’s decline gold would break above the declining red resistance line, but the opposite happened. The rally in the precious metals market may have already run its course. In fact, it could be the case that the price of gold will soon invalidate the previous breakout above its inverse head and shoulders pattern. And when that happens, a very quick slide could follow.
Also, in Friday's pre-market trading (at the moment of writing these words), the USD Index futures are up by 0.49, while gold is down by $0.30 (so it’s basically flat). This shows us that gold is likely transitioning from the stage where its rallies were euro-weakness based to a stage where its rallies would be USD-weakness based. And more precisely, where gold’s declines would be based on the strength of the USD Index.