Gold Prices Could Tumble if Dollar Soars

Based on the May 18th, 2012 Premium Update. Visit our archives for more gold & silver analysis.

Gold, traditionally a safe-haven asset, has been moving in tandem with riskier assets such as equities, industrial metals and oil this year, as investors for some reason which is difficult to fathom, have turned to the supposed “safety” of the dollar.

Writing last week in the Financial Times, Bill Gross, manager ofPimco, the world`s largest bond fund, was ripe with metaphors. He compared the world’s larger economies to the mighty whale which depends upon plankton (the smaller economies) for its survival. He called the troubles in the Eurozone a localized tumor which threatens to spread.

The time where investors are no longer willing to accept negative yields on US Treasuries is near, warned Gross.

“With the US suffering a credit downgrade to AA and offering negative 200 basis point policy rates for the privilege of investing in Treasury bills, the willingness of creditors – as opposed to debtors – to support the existing system may soon fade,” Gross wrote in a Financial Timeseditorial published last Tuesday.

“With dollar reserves widely dispersed in China, Japan, Brazil, and other surplus nations, it is fair to assume that there will come a point where 2% negative real interest rates fail to compensate for the advantages heretofore gained in buying sovereign bonds,” he added.

Gross recently cut his exposure to Treasuries, reflecting his negative outlook for US government debt. His USD 252 billion Total Return Fund held 32% in US Treasuries and Treasury-related securities as of the end of March 31, down from 37% as the end of February, according to Pimco’s website.

In his investment outlook for May, Gross warned thatinflationin the US, which currently stands at 2.7%, is set to climb and further erode returns on government debt. (Needless to say, inflation is a boom for gold.)

Gross wrote in the Financial Times:

“Now the tides may be turning as once minuscule global economies find themselves in possession of a plethora of reserves. The hunted may be turning into the hunter and the global monetary system, which has evolved and morphed over the past century – but always in the direction of easier, cheaper and more abundant credit – may have reached a point at which it can no longer operate in the same way. Major changes to our global monetary system may lie on a visible horizon.”

Gross is not alone in his warnings regarding US Treasuries. Investors such as Peter Schiff and Jim Rogers have also voiced concern.

Peter Schiff, CEO ofEuro Pacific Capital, said earlier this month that the US bond market and dollar were headed for a collapse due to the inability of theFederal Reserveto service the nation`s debt with “artificially low” interest rates. Then again, it was said also years ago.

Let’s take a look at the charts (courtesy by http://stockcharts.com.)

The index continued to rally this week and the move is visible even from this perspective since the index level is considerably higher than it was last week. The 1.3 point, 1.6% increase seen in the USD Index since last Thursday has seemingly ended the narrow trading range anomaly which we have commented on in previous weeks. The move to the upside brings the index close to its 2012 high but, more importantly, above the lower long-term declining resistance line.

It seems quite possible that the rally will continue although a short pause is possible first. If the index moves above 82.5, the next resistance to be encountered will be in the 87 to 90 range, which is considerably higher than where we are today. Such a 5% to 9% move to the upside in the USD Index could be devastating for precious metals prices.

In the medium-term USD Index chart, it does seem that a period of consolidation or sideways trading could be in the cards. This would further confirm the recent breakout which has, of course, already been confirmed by three consecutive closes above the 80.5 level. If a period of sideways trading is seen now, this will increase the bullish potential for the index in the days and weeks to follow.

Now, let’s see how Euro performed last week.

In the long-term Euro Index chart, we see quite the opposite picture. In fact, if the Euro Index moves lower from here, it could complete the bearish head-and-shoulders pattern. This would likely lead to further significant weakness for the Euro Index and additional USD Index rally.

Summing up, the recent moves to the upside and the bullish outlook for the USD Index have bearish implications for gold investors. Even though gold has declined recently, it could be the case that it will decline much more in the following weeks if USD continues its rally. Gold doesn’t always mirror dollar’s moves, but it appears to be the case this time. In fact, we have sent 2 Market Alerts today to our subscribers that addressed this issue with emphasis on yesterday’s and today’s declines.

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