Gold & Currency Outlook 090406

Dear Friends,

Gold has been a favorite play amongst retail investors who have been advised by private bankers based on the "Flight to Safety" story. In my opinion, the Gold Market is a bubble whose fate depends very much on whether the Hyper Inflation argument will hold water. This explains its high volatility in the past one year.

From the Weekly Chart we can see that Gold fell from a Historical High of US$ 1033.9 per ounce, to a Low of 681, in a classic EWT (Elliot Wave Theory) 5 Wave Motive Structure, which suggested that it was in a Primary Downtrend.

Chart Courtesy of StockCharts.Com

However, in light of the excessive printing of money by the US Government and the proposed mammoth Budget Deficits, Gold has risen from the grave with a fresh air of breath. In one major upswing, Gold rose from 681 to 1007.7, before experiencing the current correction.

It should be noted that the Weekly Stochastics was at Gross Overbought, and have crossed over to the downside.

Based on my Forecasting Model, Gold should drop to 825 +/- 20, and this current downturn is expected to last till some time in June 2009, barring any sensational new activity plans from the US Government.

This is assuming that the current downturn is a normal Trend Correction Wave in a Primary Uptrend which started in November 2008 from the low of 681. However, it is possible that this Downturn may not be a normal correction, and may actually be the start of a Primary Downtrend, as some fund managers have argued on CNBC, although they are still a minority view today.

The argument has some valid points and should not be simply dismissed. As at today, the retail investors have been pouring money into the Gold market for some time, so what happens when the flow of funds trickle to a stop? That's how markets make a Top, i.e. it reaches a point where there is no more money left that is willing to chase prices higher.

Usually, Retail Investors are the last to buy, and the ones left holding the baby, when the musical chair game stops.

Consider this argument in light of the recent call for IMF to sell down its Gold shareholdings to fund its operations to help countries that are currently in financial trouble, and we have an ever growing wave of higher and higher probability of a market downturn.

I do admit to a contradiction in my analysis. On the one hand, I am very concerned about the excessive printing of money by the US Government. This has been mentioned in many of my blog articles, the most recent being the article on 19 March 2009, entitled US Government Continues to Print Even More Money!" and the most detailed being The Inevitability of A US Dollar Devaluation Crisis published on 9th February 2009.

On the other hand, I am not a firm believer in the Gold Uptrend, and the "Flight to Safety" argument. Why?

This is because of what George Soros calls the Reflexivity Theory. The market has already acted on the "Flight to Safety" story. In my opinion, to act now, on this story, is to court the ever increasing risk of a potential bursting of the bubble.

If anything, I would put my money on Silver and Plantation & Mining Stocks or ETFs (Exchange Traded Funds) as the appropriate hedge, should the Hyper Inflation and US Dollar Devaluation Crisis risks increase to a level that is considered dangerous.

However, before we dismiss the Gold Hyper Inflation Hedge argument, let's consider the risks associated with the US Dollar from a Technical Analysis perspective of the US Dollar Index.

A review of the Weekly US Dollar Index Chart reveals increasing Probability of a US Dollar downturn against the major world currencies. The USD Index had breached the previous high of 88.46, but had not made convincing progress as it turned down at 89.62. Usually, this phenomenon is a signal of a potential Market Top, and the Index fell by 7.8% in the two weeks immediately after making the new High.

Chart Courtesy of StockCharts.Com


The Index has made a comeback in the last two weeks, having made a Pivot Low at 82.63, but the Weekly MACD is showing a Divergence, and is still trending down, and so is the Weekly Stochastics, which has fallen from the Gross Overbought Zone.

Currently, the Index is supported by the SMA200 (Simple Moving Average for 200 Weeks, i.e. almost 4 years) at 82.9. Should this level be broken, then we can expect the US Dollar to face further devaluation pressures.

Nevertheless, a review of the Daily USD Index Chart shows the Index in the process of attempting to rise, with the Daily Stochastics rising, and the Daily MACD about to turn up. However, the upturn is not strong, suggesting a lack of conviction in the market for continued strength in the US Dollar.

Chart Courtesy of StockCharts.Com

The USD Index is at a critical phase. If the present attempt to rise above the latest High of 89.62 fails, then, it is possible to see a major downturn in the US Dollar in the Medium Term.

What is interesting is that despite the claims of a potential disintegration of the European Union and thus, the dissolution of the Euro, the Euro Index is starting to show signs of life, of a potential strengthening. Both the Weekly MACD and Stochastics are now trending up, and the Euro Index has broken above its SMA200.

Chart Courtesy of StockCharts.Com

Based on the Charts, it would seem that the risk of Hyper Inflation is still sufficiently low for us to act today, although this risk seems to be on the rise. Nevertheless, the Probability has increased that the US Dollar will weaken against other major world currencies in the next few months.

In conclusion, the Probability is increasing that in the Medium Term, (3 Weeks to 3 Months) the US Dollar will weaken against the Euro, while Gold is expected to fall to 825 +/- 20.

Please be reminded on the Liability Exclusion Clause, which is at the top of my blog page, i.e. that the final trading decision is yours, and I will not be responsible or liable for any losses you may incur from whatsoever reason. :)

Best wishes,

Ooi

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