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Dollar-Neutral Gold

Adam Hamilton
Oct 22, 2010

Gold has enjoyed a relentless and rather one-sided rally since late July. Up 18.9% at best over an 11-week span where nearly 2/3rds of the trading days enjoyed gains, some traders are wondering if this metal is getting overbought. Tuesday’s sharp 2.9% retreat certainly amplified these fears. But interestingly, due to dollar distortion this recent gold rally isn’t as strong as it appears.

The benchmark US Dollar Index, which tracks the value of the US dollar relative to 6 other major currencies, has been decaying rapidly since late August. Topping the day before the flagship S&P 500 stock index (SPX) bottomed, the USDX had sunk 8.0% at worst last week by the same day gold hit its latest interim high. Over this exact 7-week span, gold rallied 11.3%. But the weak dollar was responsible for the great majority of gold’s strength.

This revelation has all kinds of implications for gold, not the least of which is this metal’s global rally was far more muted than our American dollar-centric perspective suggests. And since gold hasn’t rallied as far and fast as we think here in the States, its odds of being overbought are much lower. And if gold isn’t yet overbought, then there is no need to fear a correction. Today’s upleg has plenty of room to run higher.

As American traders, we’ve spent our entire lives in a US-dollar-dominated world. Thus it is challenging for us to think outside the dollar box, because we’ve never really needed to. Yet in today’s increasingly interrelated and interdependent global capital markets, we have to expand our perspective. Just as dollar-denominated price levels shape our trading decisions, foreign traders’ psychology reflects the local-currency price levels they are seeing.

Viewing gold in dollar-neutral terms, seeing it as most of the rest of the world outside of the States does, offers a very different picture of today’s rally. Much of its recent dollar-denominated gains are merely an illusion, the result of the Fed’s ongoing dollar devaluation. The more inherently-worthless fiat dollars are created out of thin air, the more it takes to buy any asset with real intrinsic value. Particularly gold.

My favorite proxy for seeing gold as most of the rest of the world sees it lies in denominating gold in euros. Though this young composite currency was only born in 1999, it has been wildly successful. Despite the many major flaws it shares with the US dollar, primarily the fact it is backed by nothing but faith in government, it is the only other real contender for world-reserve-currency status.

The euro is already the world’s second-largest reserve currency held by central banks. Around 325m Europeans use it daily, along with 175m more people in countries outside of Europe with currencies pegged to the euro. In June 2010, the combined value of all euro banknotes (paper bills) and coins in circulation (€800b) exceeded the US dollar’s total physical circulation! And everyone from major OPEC nations to supermodels are starting to accept or even demand payments in euros instead of dollars.

The upstart euro also dominates the US Dollar Index, accounting for 57.6% of its weight. For trading purposes, the USDX is the dollar. The vast majority of times traders use the word “dollar”, they are really technically referring to the USDX. So if you want a dollar-neutral perspective on anything, looking at its price through the euro lens is the best way to get it. All American traders need to watch euro gold.

Denominated in euros, the recent gold chart looks far different from what we are seeing here in the States. Euro gold is actually consolidating, its next upleg has barely started and this metal remains well below its record highs. Euro gold is rendered in blue here, superimposed over the dollar’s exchange rate with the euro in red. The recent dollar-gold rally is not all it seems, much of its gains have been an illusion.

While dollar gold hit a new all-time record high of $1380 last week, euro gold’s own all-time record high of €1042 was achieved way back on June 7th. There was a full-blown euro panic at the time, with traders foolishly assuming this composite currency was going to plunge forevermore. But this selloff was highly emotional, irrational, and unsustainable as I explained during its midst. It was actually an incredible euro buying opportunity!

As an aside, the only reason the euro plummeted earlier this year was because the USDX was rocketing higher. And the dollar was rallying solely because the US stock markets were plunging in their first major correction of this young cyclical bull. Ever since 2008’s epic once-in-a-century stock panic, whenever the stock markets are weak fear flares so capital flees into the relative safety of cash (US dollars) and US Treasuries. Thus the dollar is slaved to the SPX’s fortunes, not the other way around as most assume.

The euro bottomed in early June the exact day the SPX did, and that SPX low was why the USDX topped that very day. Ever since that SPX-driven euro panic climaxed, the euro has been rallying on balance. It was up 18.2% as of last week, peaking the same day gold hit its latest interim high and the USDX hit its latest interim low. Through the mechanism of stock-market psychology heavily impacting the US dollar, the global markets are more interrelated today than ever before.

Euro gold itself bottomed the same day in late July that dollar gold did, deep in the heart of the summer doldrums. Since then, it has only rallied 10.1% over 11 weeks. And at its latest interim peak of €984 on October 13th, euro gold was still 5.6% under its early-June record high. Obviously this technical behavior is way different from what dollar gold has experienced. Compare the last few months of the chart above with a dollar-gold chart, and the differences are enormous.

While dollar gold rallied 11.3% in just 7 weeks since late August as the USDX plummeted, euro gold is dead flat over this exact span! That’s right, euro gold closed at €980 on August 25th at the USDX’s latest peak and closed at €980 on October 14th at the USDX’s latest interim low. In dollar-neutral terms, the gold price has done absolutely nothing over the past 7 weeks! What we perceive as a rally here in the States is merely a rapid devaluation of the US dollar. Gold is merely holding its own, not soaring.

Though the American capital markets are massive, world-leading, and incredibly important, to investors and speculators in most of the rest of the world the recent gold action looks just like this euro-gold chart. Boring and flat. Our subscribers have access to large high-resolution charts on our website that show today’s secular gold bull rendered in 10 major world currencies. And denominated in most, gold has just been consolidating high since spring. Nothing exciting has happened yet in this new upleg.

Since this secular gold bull entered Stage Two in mid-2005, when global investment demand overtook US-dollar-devaluation as this metal’s primary driver, no gold upleg has ended until it became universal. Gold first had to be bid up everywhere, rally to simultaneous new highs in most major currencies, before it had run too far too fast and needed to correct to rebalance away excessive greed. And as euro gold reveals, we remain far from that point today.

Most foreign investors haven’t enjoyed much of a gold rally at all lately, so there is little greed to eradicate. And instead of soaring too far too fast, gold has been consolidating in an uninspiring flat-lined manner. Until we see a serious rally to new highs in euro gold, the best dollar-neutral proxy for this metal, it is highly unlikely that gold is overbought and due for a correction. Today’s upleg has barely started.

What we Americans have seen in gold over the last 7 or 8 weeks is simply a repricing due to our rapidly-falling currency. This also holds true in many other key commodities, and even in the general stock markets to some extent. Any asset that is traded globally yet primarily priced in US dollars has to rise to reflect the weaker dollar. The more of these the Fed prints, the more of them it takes to buy anything with real intrinsic value.

Actually, this dollar-neutral perspective on gold provided by viewing it priced in euros has been very important for this entire gold bull. This next chart zooms out to encompass gold’s whole secular bull since 2001. Every major upleg in gold, the giant surges higher that drove huge gains in gold stocks, occurred universally as global investors raced to bid gold higher worldwide. Americans can’t do it alone.

The investment-demand-driven Stage Two of this gold bull didn’t ignite until mid-2005 when euro gold finally broke out above its long-vexing €350 resistance. Even at the time I strongly suspected this watershed event marked the dawn of Stage Two. Indeed since then there have been 4 major global uplegs in gold, each driving up euro gold to dazzling new highs.

Since the US dollar has been languishing in a 9-year-old secular bear thanks to Washington’s horrible fiscal and monetary policies, this euro-gold chart is much more representative of gold’s true progress. In these dollar-neutral terms, by euro gold’s latest June 2010 highs gold had nearly quadrupled since early 2001! And these gains were all the more impressive since the euro had rallied 25% over this exact span.

The gigantic difference between the 275.6% euro-gold rally and the 25.2% euro rally represents the enormous Stage Two global investment demand for the yellow metal. Before that pivotal €350 breakout in mid-2005 marked the end of Stage One (dollar-devaluation-driven), the vast majority of foreign traders didn’t even believe a secular gold bull existed. But ever since then, fewer and fewer doubters remain. All over the world, for all kinds of reasons, investors have been increasing their capital allocated to gold.

And American traders shouldn’t underestimate the impact of European gold demand specifically. Though Europe has lots of problems created by bloated governments, just like we do here in the States, that continent still holds vast private wealth. And European investors have a much greater cultural affinity for gold than Americans will ever have. Since Europe suffered through horrible wars and mind-boggling fiat-currency inflation firsthand, Europeans deeply understand gold’s importance and true role.

And just like Americans got excited last autumn when dollar gold first headed over $1000 for good, Europeans are going to get fired up when euro gold finally powers decisively over €1000 and holds there. Though €1000 was first hit back in May, I argued at the time it probably wouldn’t hold. Euro gold had rallied too far too fast and was definitely overbought, and the radically-oversold euro was due for a major rally. And indeed the euro soon shot higher as expected and euro gold corrected then consolidated.

But today euro-gold €1000 is easily in reach. Since its initial appearance in mid-May, euro gold has averaged €966 over the 5 months since. This is a long base, a strong foundation, for the final decisive technical assault on €1000. As I wrote back in May, I fully expect €1000+ gold to be the new norm sometime this autumn. In the coming months as euro gold punches through this critical psychological level, it is going to drive great mainstream interest in new gold investment throughout Europe.

And that’s when today’s new gold upleg will truly get underway, rallying globally in every major currency and not just in US-dollar terms. This is very encouraging for American investors and speculators. When investors all over the world start chasing gold again, it is going to rally a lot faster than it has been recently with just a little fraction of American traders buying gold. This dollar-neutral perspective heralds an accelerating gold upleg, not the big correction many dollar-deceived American traders have started to fear.

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The bottom line is American worries about gold getting overbought are based on a distorted dollar-centric worldview. In dollar-neutral terms as represented by euro gold, this metal has actually been merely consolidating high since spring. And gold has been dead flat since late August once the effects of the rapid dollar devaluation are filtered out. Gold doesn’t get overbought until late in universal rallies. All we’ve seen lately is simply a revaluation to reflect the weaker dollar.

And this dollar-neutral euro-gold perspective reveals far more than gold’s complete lack of overboughtness and greed today. Euro gold has been forming a beautiful high base just under the psychologically-massive €1000 milestone. Once €1000 breaks decisively, tens of millions of mainstream European investors are going to get a lot more interested in gold. Their buying alone should accelerate a universal upleg.


Adam Hamilton, CPA
Oct 22, 2010

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com. Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

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