The US Dollar: Technically Time For Consolidation
Sunday, April 20, 2008 at 06:53PM
Gold Prices in Gold, Other
It is quite an unusual occasion to see a major currency in a developed country lose more than 10% of its buying power in less than a year. However, these are unusual times!

The US Dollar: Technically Time For Consolidation

But no matter how dire the fundamentals are for the greenback, it should still adhere to the technical rules that govern financial markets. Therefore, despite there being a massive bear market in the US dollar, we should still see periods of consolidation or perhaps even minor bear market rallies.

The last time the USD went through a period of consolidation was back in 2006 where the index consolidated in the 84-87 range. We think that the dollar will probably go through a similar consolidation over the next few months. However the confirmation will come when the greenback breaks out of its current descending triangle formation

The US Dollar: Breakout Due

Another indication that a breakout is due is the decreasing volatility we are seeing in the USD. This is shown by Bollinger Bands (a measure of volatility) below . As you can see the bands are coming closer and closer together which shows volatility is in decline.

The US Dollar: Volatility Decreasing

This breakout will probably be caused by the severity, or lack of severity, of the upcoming Fed rate cut. The fed will probably cut rates again on the 30th of April, with the most likely option at the moment being the half point cut. The futures market is indicating that there is a 82% chance that the rates will be cut by 25 basis points. This is quite a change from recent months where half point cuts have been almost fully priced in before the meeting. This change happened at the last rate cut, when the Fed cut rates by 75 basis points. We thought this was a big shift in the psychology of the Fed and its rate cutting policy. Whereas before the Fed had always opted for the most aggressive possible cut, in this instance it did not. Before if the market was split between say half a point and a quarter point, the Fed would go for the half point. At the last meeting, the market was split between a 75 and 100 basis point cut, and for the first time the Fed choose the less extreme option. This has shown us that the Fed has changed from simply cutting rates at all costs, to actually exercising caution before slashing rates recklessly.

Therefore if we see a quarter point cut or even no cut at all, this will stall the US dollar which is currently in freefall. In our opinion it would take an aggressive cut of half a point or more to keep the momentum in the greenback decline. But even a half point cut may not be enough to keep the USD falling down and gold zooming up. The fact of the matter is that people are realising that these rate cuts cannot continue forever. The Fed is now admitting that inflation may be becoming a problem and so they will need to take that into account when making the decision on how much to cut the rates. Therefore it is likely that we will see a more cautious policy in the future.

So what does this all mean for gold prices?

The reason we spend a great deal of time studying the USD is because of how strongly it is linked to gold prices, probably more that any other factor. Obviously if the US dollar embarks on a bear market rally, gold prices will correct severely. However even a period of consolidation would be enough to send gold prices south. This is because gold has run up very high and there is a lot of speculative money in the market which will move quickly to take profits if the USD freefall appears to falter. For example back in 2006 gold prices corrected from $730 to $542 when the greenback entered a period of consolidation. We think it is likely that gold prices will move towards its 200 day moving average and remain fairly flat over the summer doldrums, consolidating these new price levels.

Having been heavy buyers over last summer, we have taken profits on some of our precious metals investments and we may take more in the coming weeks. This means we will have cash on the sidelines ready to take advantage of the great buying opportunities that will no doubt present themselves over the northern hemisphere summer. We still believe in the long term bullish fundamentals driving this gold bull market and we expect to see gold prices of $2000+ by next year.

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