The U.S. Dollar Index, which measures the U.S. dollar versus a basket of foreign currencies, is still perched precariously just above the breakout point of its 2015-2016 consolidation. 

With the market closing the week at 101.1, the U.S. dollar must remain above 99.5 on the Index. The U.S. dollar must stay above to avoid an extremely bearish reversal pattern which is tentatively taking the shape of a Head & Shoulders top formation (blue callouts).

 

U.S. Dollar Index

A sentiment accompanied the initial surge in the U.S. dollar seen immediately following Trump’s presidential victory. This sentiment suggested the new administration would reverse trade deficits, boost growth, and cut the US national debt. The sluggishness of the U.S. dollar’s advance in recent weeks suggests that the market is having second thoughts about this initial determination.

From a sentiment standpoint, a bearish outlook for the dollar seems to be a possibility. A few in the mainstream media are contemplating – and for that reason, it represents a compelling contrarian viewpoint.

Euro Fears? The Contrarian Stance

At the same time, reports regarding the possible breakup of the euro-zone have reached almost a fever pitch. This is following the UK’s decision to leave the EU last June and uncertainty regarding elections across mainland Europe in 2017.

It seems “everyone” knows the euro is set to disintegrate over the next few years. For that reason, we believe the trade is extremely crowded. As contrarians, when everyone knows that something is set to happen, we must at least ask the question: “Is there not an alternate possibility?”

While the Euro-zone has a unique set of political/economic problems and may need substantial reforms, we must consider several possibilities. The “news” and currency come together because of the price.

Ironically, the fact that most investors are sure of the euro’s imminent collapse leads us to strongly favor the stance that the euro is set to begin a multi-year advance.

And if the euro is nearing the start of a significant advance, the dollar should act conversely. As the most significant component of the U.S. Dollar Index above is the euro (at 57%), a rising euro will cause the dollar to fall.

Gold

All else being equal, a falling dollar will tend to cause more investors to seek protection in gold.

We do not want to call the top in the dollar prematurely. This is before we see a breakdown below 99.5 on the Dollar Index. However, the U.S. dollar currency is acting significantly weaker than it “should” be. Henceforth given the two-year consolidation is seen before the breakout.

Something is not right with the way the dollar is behaving technically. If it does not manifest immediately, our best assessment is that U.S. dollar weakness should become evident by 2018.

U.S. Dollars & Bonds

Bonds are U.S. dollars that people receive in the future. We continue to suspect that a generational timeframe top has been put in on long-dated U.S. bonds. Shown below is the price of the US 30-year bond. Recall that the worth of bonds moves opposite to yields, and so a record-high price equates to record-low yields.

 

U.S. Dollar The price of the US-30 year bond

From a technical standpoint, tops after long-term advances tend to be characterized by orderly progress which then becomes disorderly.

In the case of US bonds, we had observed an unprecedented 36-year advance in price, defined by an orderly (magenta color) rising channel from 1980 – 2016. The increase in bonds then became disorderly, taking on characteristics of a parabolic blow-off. Also, they are breaking the top trend boundary (shown in blue, above). The top saw a price of 175 on the 30-year bond, which corresponded to a record low yield of 2.1%.

Following the blow-off, we observed a quick 17% drop in bond prices in 2H 2016. Such a sharp decline from an all-time high suggests an initial exhaustion sell-off after an unsustainable advance.

U.S. Dollar and Bond Value Collapse

We are not expecting a collapse in bond prices immediately. However, if the above analysis is to remain valid, the 30-year yield at 2.1% should not be matched again. This is perhaps ever still in our lifetimes.

Following 36 years of rising bond prices, it is equally fathomable that the bond market could see 36 years of falling prices which would correspond to 36-years of rising interest rates.

Investors had become accustomed to buying bonds for safety over the last generation. Years of falling bond prices should represent an essential component of the long-term thesis for precious metals. 

Some of that safety-seeking capital that in the past would flow to bonds should in the future go toward gold.

The size of the US bond market alone is near $12 trillion. All of the gold mined in the history of the world is valued at $6.6 trillion. It is now at $1,300 per ounce. Yet, nearly 50% of that gold held in jewelry, mostly in Asia. We can see that it would not take a large percentage of capital to flow from bonds to gold to cause a significant price acceleration in the precious metals.

 


Christopher Aaron,
Bullion Exchanges Market Analyst

Christopher Aaron has been trading in the commodity and financial markets since the early 2000s. He began his career as an intelligence analyst for the Central Intelligence Agency, where he specialized in the creation and interpretation of the pattern of- life mapping in Afghanistan and Iraq.

Technical analysis shares many similarities with mapping: both base on the observations of repeating and embedded patterns in human nature.

His strategy of blending behavioral and technical analysis has helped him and his clients to identify both long-term market cycles and short-term opportunities for profit.

This article is a third-party analysis. It does not necessarily match the views of the Bullion Exchanges. Readers should not consider this as financial advice in any way.

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