Dollar Down, Gold Up, Right? Wrong, Says Chartist
U.S. dollar down, gold up. Right? It's simple and common investment axiom. But guess what? It's been absolutely wrong for more than two years.
The relationship changed in October 2008. but I'm still amazed how many sophisticated investors will accept a statement like this as truth without first looking at a chart to verify it. This simple but incorrect thinking has resulted in thousands of investors making decisions based on a myth. Some buy physical gold. Some buy gold ETFs, and others buy into the gold sector when the U.S. dollar develops weakness.
The trending behavior of the Dollar Index has little impact on the underlying trend of gold. Look at the period starting November 2009 and ending May 2010. The U.S. dollar has a strong rising trend starting from a low of $0.74 and ending at a high of $0.88. During the same period, the price of gold did not fall, but rose from $1,162 to $1,249.
Perhaps that was an accidental relationship. From May 2010 the dollar fell from $0.88 to a low of $0.77 in November 2010. This dramatic weakness looks to prove the relationship because the gold price increased from $1249 to $1381 over the same period. If we focus just on these dates it looks like the thinking about this intermarket relationship is correct and we ignore the continuity of the rising gold price in a long term pre-existing trend. We also completely ignore the sharp rise in the dollar from $0.80 to $0.84 in August 2010 which had no impact on the direction of the rising gold price.
Which brings us to the current situation, where the U.S. dollar has rebounded from near $0.77, reaching new highs around $0.81. The strengthening dollar should be negative for gold, but this has not happened. The gold price has retreated, but it does not show a trend break. The gold price retreat is back to the underlying long-term trend line and gold traders will look for a rebound from this area irrespective of the behavior of the US dollar.
There are some strong intermarket relationships. The intermarket relationship between the U.S. dollar and gold is not one of them. The charts clearly show that each should be traded on its own merit and trend behavior with only cursory reference to the behavior of the other.
Blind acceptance of market axioms is an excellent way to destroy portfolio profits and avoid investment opportunities. Basic chart analysis protects profits and identifies opportunities.
Daryl Guppy is a trader and author of Trend Trading, The 36 Strategies of the Chinese for Financial Traders –www.guppytraders.com. He is a regular guest on CNBC's Asia Squawk Box. He is a speaker at trading conferences in China, Asia, Australia and Europe.
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