Today’s beaten-down US dollar is a major short-term risk for gold. For decades this yellow metal has often inversely mirrored the fortunes of the world’s reserve currency. Dollar trends are important trading cues for highly-leveraged gold-futures speculators, who wield outsized influence over gold prices. So an overdue mean-reversion rebound rally erupting in the US dollar will unleash serious gold selling pressure.
Gold has proven the ultimate universal global money for millennia now, and its US-dollar price American speculators and investors follow is simply these currencies’ exchange rate. So flowing and ebbing dollar levels directly impact prevailing gold prices. Gold generally tends to rally when the dollar weakens, then sell off when it strengthens again. The leading dollar benchmark reveals this powerful inverse correlation.
That is the venerable US Dollar Index, which was launched way back in March 1973. This USDX applies a weighted geometric mean to a basket of major world currencies to track the relative value of the US dollar. The Eurozone countries’ euro, Japan’s yen, and the United Kingdom’s pound sterling dominate the USDX commanding 57.6%, 13.6%, and 11.9% of its total weighting. Three other currencies round it out.
The USDX’s sometimes-domineering influence over gold prices has faded off traders’ radars in recent years. That’s because gold and the US dollar rallied simultaneously through most of 2019, leading many to assume that dollar-gold link was broken. But it merely went dormant, taking a back seat to another big gold driver. Gold was powering higher on massive inflows of stock-market capital through major gold ETFs.
The overwhelmingly-dominant ones are the GLD SPDR Gold Shares and IAU iShares Gold Trust. Just over a month ago I wrote a comprehensive essay analyzing this critical gold-moving dynamic. In times when stock-market capital is deluging into gold, this metal can indeed decouple from the US dollar because stock traders don’t care about it. They chase gold upside momentum, fueling virtuous circles of buying.
But much of the time stock traders aren’t frenziedly shunting vast amounts of money into gold via those major-gold-ETF conduits. In these more-normal conditions, speculators’ gold-futures trading dominates gold’s price action. The incredibly-dangerous leverage extremes these guys run force them to myopically trade very-short-term time horizons. Nothing motivates them to buy or sell gold futures more than dollar swings.
This first charts proves gold’s longstanding opposition to the US dollar’s fortunes remains alive and well. It superimposes gold’s price action during this secular bull over the US Dollar Index’s own along with some of its key technicals. Despite episodes when big differential gold-ETF-share buying worked to overwhelm and suppress the classic dollar-gold relationship, it has still greatly influenced this overall gold bull.
All secular bull markets are an alternating series of uplegs followed by corrections. This current gold bull has enjoyed four major uplegs and suffered three major corrections. And its fourth correction is underway today. That makes for eight separate bull segments so far, which are separated here by vertical red lines. In fully 7/8ths of these segments covering the large majority of this gold bull, gold inversely mirrored the USDX.
That happened to varying degrees, depending on how much capital stock traders were pumping into or out of physical gold bullion through those big gold ETFs. But major gold uplegs coincided with US Dollar Index downlegs, and major gold corrections unfolded on USDX rebound rallies. That’s why the current low US dollar is a serious short-term threat to gold. The USDX slumped to a 2.3-year low in late August.
But this year’s volatile US-dollar action began during mid-March’s brutal stock panic. That was spawned by governments’ draconian national lockdowns to attempt to slow the spread of COVID-19. Those fueled tremendous fear, traders had never seen anything like that. As stock markets plummeted, there was a stampede for the exits and a mad dash for cash. Save-haven US-dollar demand explodes during stock panics!
Before that ugly stock-market selloff cascaded into a full-blown panic, which is a 20%+ plummeting in two weeks or less, gold climbed to $1675 in early March. Not coincidentally that was the same day the USDX bottomed after plunging 4.9% over 12 trading days. Then as the stock selling intensified and the Fed panicked slamming rates back to zero, the oversold USDX rocketed higher in a stratospheric spike.
The red lines above segment gold uplegs and corrections, which don’t always precisely match the days the dollar tops and bottoms. But over the next 8 trading days as the USDX skyrocketed a stupendous 8.1% higher, gold cratered a horrendous 12.1%! When the US dollar is surging, gold-futures speculators rush to dump their long positions and pile on to the selling momentum with new shorts crushing gold.
While compressed into a lightspeed-fast timeframe, that third correction of this gold bull had the same strong-dollar driver as the first two. Back in late 2016, the first correction saw gold plunge 17.3% over 5.3 months partially on a sharp 7.1% USDX rally. That catapulted this leading US-dollar benchmark to a lofty 14.0-year secular high! Gold’s second correction shared this same catalyst of a big-and-fast US-dollar surge.
In roughly the first half of 2018, gold plunged 13.6% over 6.7 months on a sharp 8.2% USDX rally. A much-stronger US dollar has proven a serious short-term threat to gold during this bull, and remains one today. Those three earlier gold corrections averaged 14.3% losses over 4.1 months, which cascaded on the USDX soaring a tight average 7.8%. Those are mighty rallies by glacially-slow currency standards!
After its epic 2020-stock-panic surge, the US dollar was extremely overbought. So it immediately rolled over into a major downleg. That combined with huge differential gold-ETF-share demand is the reason gold was able to soar 40.0% higher over the next 4.6 months. Had the stock-panic-goosed USDX not collapsed 9.6%, gold’s last major upleg would’ve been much smaller. The US dollar’s fortunes still drive gold.
The USDX’s plummeting last summer was driven by heavily-crowded short selling in this world’s reserve currency. Professional traders piled on to the dollar-collapse bandwagon. Not only had the Fed slashed rates to zero killing yields in dollar-denominated US Treasuries, but US-government debt was soaring on trillions of dollars of pandemic-stimulus spending. So dumping the US dollar became fashionable and popular.
Gold started shooting parabolic in late July, soaring a colossal 13.5% higher in less than several weeks! Extreme gold-ETF-share buying was the primary driver. But also boosting gold was the USDX’s sharp 3.2% plunge over that same short span. Gold peaked at $2062 in early August the same day that this dollar benchmark slammed into its initial interim low. The next day’s dollar bounce kicked off gold’s selloff.
The former was short-lived, as the USDX soon tumbled to even-lower lows in late August. But with gold sentiment euphoric and gold technicals extraordinarily overbought, the stronger dollar had already done its damage. With gold’s upside momentum broken, the big differential gold-ETF-share buying in GLD and IAU mostly dried up. Gold consolidated high as the USDX drifted, then resumed selling off as the dollar bounced.
At worst by late September, gold’s selloff extended to 9.8% nearing formal correction territory starting at 10%. During that 1.6-month span, the USDX merely climbed 1.7%. But if you look at higher-resolution daily charts of gold and the US dollar since early August, these competing world currencies are almost moving in perfectly-opposed lockstep. As during this bull’s past corrections, gold is back at the mercy of the dollar.
Unfortunately that is really bearish for gold over the near-term. The battered and heavily-shorted USDX is still way down near major secular lows. That implies it has a lot more mean-reversion rallying left to do, fueled by both short-covering buying and momentum-chasing long buying. And any sustained US-dollar uptrend will force gold into a deeper correction more in line with its bull precedent. That’s a big risk for gold!
One way to quantify the US Dollar Index’s short-term upside potential is looking at where it has traded relative to its 200-day moving average during past gold corrections. Dividing the USDX’s daily close by its 200dma yields the Relative USDX or rUSDX. That is based on the same Relativity Trading principles I analyzed for gold in another essay a month ago. How high was the rUSDX when past gold corrections ended?
This gold bull’s first three corrections finally bottomed at rUSDX levels of 1.071x, 1.044x, and 1.049x. These average out to the US Dollar Index surging to 5.5% above its 200dma. Dollar mean-reversion rallies after major selloffs usually don’t end until considerably over that key technical baseline. But the highest the rUSDX has been since late August’s US dollar secular low is merely 0.974x in late September!
At best this leading US-dollar benchmark was still 2.6% under its 200dma, which is a far cry from that gold-correction-ending 5.5% over. And since the USDX has retreated again as of the middle of this week, it is back down to 3.6% under or a 0.964x rUSDX. The hammered US dollar has much farther to bounce yet before it mean reverts high enough to rebalance away oversold technicals and still-bearish sentiment.
Mean-reversion rebounds fueled by short covering don’t necessarily need a catalytic driver, but there are still plenty of potential ones for the USDX today. In recent weeks the US dollar has rallied in solid up days whenever the perceived odds wane of the US Congress agreeing on another big round of pandemic-stimulus spending. That moderates the ballistic trajectory of US debt growth, making the dollar look stabler.
The upcoming US-election results could fuel major dollar buying. They could change the way currency traders are gaming the likelihood of another big debt-financed government-spending binge. They could ignite stock-market selling fueling safe-haven demand for the US dollar. And remember that over 4/7ths of the USDX’s weighting is in the euro alone! So European events hitting the high euro could drive dollar buying.
The European Central Bank could force its rates even deeper into negative territory, or unleash vast new quantitative-easing bond monetizations weakening that currency. The Eurozone’s economic outlook could darken, making the US look relatively more attractive. COVID-19 infection rates in Europe could keep resurging, leading to more national-lockdown threats from those countries’ governments. Lots could happen.
Only time will tell how high the USDX’s overdue mean-reversion rebound rally will climb, but precedent suggests big dollar gains are likely. This gold bull’s past-few-corrections average rUSDX level of 1.055x when they bottomed implies a lofty 102.2 USDX based on its current 200dma this week. That is a huge 9.4% higher from today’s dollar levels, and would make for a total USDX rally of 10.9%! But I don’t expect that.
In recent years the USDX hasn’t soared back up over 102 without major surprises, including Trump’s stunning presidential victory four years ago and this year’s ultra-rare stock panic. Those shocks helped pull up the USDX’s average rally of 7.8% during this gold bull’s corrections. That average would imply a USDX topping around 99.4, 6.4% above this week’s levels and making for a 7.8% total mean reversion.
The bare-minimum USDX rally gold traders should look for is a 200dma approach, which is way smaller than gold-bull precedent. The USDX’s 200dma is running 96.9 in the middle of this week, though it continues to fall with the dollar so pummeled. Mean reverting back up to that 200dma now would require the USDX to surge another 3.7%, bringing its total rally off late-August lows to 5.1%. That’s troubling for gold.
Even this lowballed really-conservative dollar-bounce estimate suggests nearly 3/4ths of the dollar’s gains are still coming! And gold has behaved very poorly on recent bigger USDX up days. Gold’s sharp 1.9%, 2.2%, 1.5%, and 1.6% daily plunges that happened on September 21st, September 23rd, October 6th, and October 13th were driven by larger 0.7%, 0.4%, 0.3%, and 0.5% USDX up days! They are a real threat.
The reason is speculators’ current gold-futures positioning. These traders are still largely betting on more near-term gold upside, their outlook is quite bullish. So if the USDX surges, they have vast amounts of gold-futures contracts they will need to sell fast to shift their capital out of harm’s way. The crazy leverage inherent in gold-futures trading makes it exceedingly unforgiving. These guys can’t afford to be wrong for long.
Each gold-futures contract controls 100 troy ounces of gold, which is worth $190,000 at $1900 gold. Yet the margin requirements for buying or selling each contract are only running $10,500. That’s the amount of cash traders have to keep in their accounts. Thus traders can legally trade gold via futures at extreme 18.1x leverage! At that level a 5.5% gold-price move against futures bets would wipe out 100% of capital risked.
So if the USDX continues mean reverting higher and pressuring gold, major selling will be unleashed in gold futures exacerbating gold’s correction. This next chart shows specs’ total long and short contracts as reported weekly in the famous Commitments of Traders reports. Gold is superimposed on top, and specs’ total gold-futures buying and selling during each of this gold bull’s uplegs and corrections are noted.
Compared to when this gold bull’s prior corrections bottomed, spec longs are still high and spec shorts are still low. In the latest-reported CoT week before this essay was published, which ended on Tuesday October 6th, total spec longs and shorts were running 387.4k and 99.0k contracts. As their green and red lines ominously reveal, big selling is still necessary before positioning nears prior gold-correction-ending levels.
As this gold bull’s first several corrections gave up their ghosts, total spec longs were running 275.8k, 258.2k, and 368.7k contracts. That third correction during March 2020’s stock panic was high since that selloff was so blisteringly fast. But these still average 300.9k contracts, which is 86.5k lower from current levels. That much selling is the equivalent of 269.0 metric tons of gold, a big slug that would crush gold lower.
Total spec shorts were running 126.0k, 250.8k, and 67.0k when this gold bull’s earlier corrections ended, averaging 147.9k. Specs would have to short sell another 48.9k contracts to get back up there, which is the equivalent of another 152.1t of gold. So gold now faces a menacing gold-futures-selling overhang exceeding 421t! That’s a lot of selling that could cascade if a stronger dollar scares these guys into fleeing.
Even if this oversold-USDX mean-reversion rally was the only near-term downside risk gold faced, it is certainly serious enough to demand caution. All of this gold bull’s prior corrections were driven by these periodic dollar surges, and today’s fourth one likely won’t prove any different. But that’s not the only big short-term risk factor plaguing gold. A couple of my recent essays analyzed some other ones to keep in mind.
This gold bull’s fourth correction likely hasn’t run its course yet, with gold overboughtness lingering and sentiment remaining way too bullish for a major bottoming. And the huge differential gold-ETF-share buying that catapulted gold’s last upleg higher has gone missing in action since upside momentum failed. As dollar-driven gold-futures selling forces gold lower, resulting big gold-ETF selling could amplify the downside.
Today’s low US dollar, which remains oversold and riddled with excessive popular bearishness, is just one of several big near-term risk factors for gold. So odds are there will be more selling to come in this gold correction. That implies better buy-relatively-low opportunities are still coming in gold, silver, and the stocks of their miners. The major gold stocks in particular tend to amplify gold corrections by 2x to 3x.
Both speculators and investors should embrace these inevitable rebalancing corrections, as they yield the best mid-bull buying opportunities within ongoing bull markets. That is when to aggressively redeploy in gold, gold ETFs, gold-stock ETFs, and individual gold stocks with superior fundamentals. Bulls’ inexorable upleg-correction cycles are great boons for traders, greatly expanding their potential gains to be won!
At Zeal we started aggressively buying and recommending fundamentally-superior gold and silver miners in our weekly and monthly subscription newsletters back in mid-March right after the stock-panic lows. We layered into dozens of new positions before gold stocks grew too overbought, which were stopped out later at huge realized gains running as high as +199%! Our subscribers multiplied their wealth within months.
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The bottom line is today’s low US-dollar levels are a serious near-term risk for gold. After the dollar’s past big selloffs, it has surged sharply higher in major mean-reversion rallies. When those unfolded during this secular gold bull, the yellow metal suffered major corrections. A rapidly-strengthening US dollar forces gold-futures speculators to aggressively dump their leveraged positions, which fuels snowballing gold selling.
With the US dollar so oversold and bearishness on it so universal, there are all kinds of potential catalysts to drive its overdue mean-reversion rally. They could come from the dollar side based on how pandemic stimulus and upcoming US elections play out. But economic weakness or health crises in Europe could also hit the euro boosting the US dollar. Gold remains at risk of further selling until the dollar normalizes.
Adam Hamilton, CPA
October 16, 2020
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