It is essential for precious metals investors to follow the valuation of the U.S. dollar versus other foreign currencies because as a general principle. This principle is the world’s reserve currency still to this day when the dollar sees periods of rapid decline investors tend to seek safety. Some of that safety flow will move into precious metals.

Below we chart the dollar index. It measures the greenback against a basket of foreign currencies. These include the euro, the British pound, the Japanese yen, and the Canadian dollar.

Since the false breakout at multi-decade highs last January, the U.S. dollar has declined with such ferocious momentum that it has surprised even our initial outlook from this past spring. Our initial target to the downside was 95.5 (green callout). This level has not only been hit but exceeded. In the wake of a dovish indication from the Federal Reserve last week that it may not desire to “normalize” its balance sheet as quickly as many assumed, the USD has continued to plummet all the way down to the nearly 3-year “Critical Support Zone” labeled below in black. This zone extends from 91.9 to 93.1 on the dollar index.

US Dollar Index

The charts have closed at 93.1 for the week; the dollar is now effectively testing this critical support zone.

U.S. Dollar Set for a Technical Bounce

Over the short term, we would expect the dollar to bounce in this region. The nature of the bounce will be critical to monitor. The false breakout pattern at a multi-decade high is a rare and significant technical signal for a possible long-term reversal. So, we expect that a bounce from current levels for the dollar will not be anything more than a relief rally. They should not exceed the declining (dashed blue) downtrend line. This scenario is in green.

A less probable scenario would be that the U.S. dollar stages a more significant relief rally which breaks its new downtrend. However, it should not exceed the resistance zone between 99.5 – 100.5.

The strength of the expected bounce will tell us much about the dollar going forward. Should the dollar stage a more significant rally, it will be signaling that the decline we expect over the coming years will be slower and more grinding in nature. Perhaps, taking an even 8-years to fall to all-time lows near 72 on the index. Two thousand eight also had these levels.

However, what if the U.S. dollars merely shows a weak bounce? If it stays below its new trendline, not exceeding 95.5 on the way higher. Then plunging through the critical support zone, the stage will set for an immediate and precipitous drop in the US currency. This will be over just the next 12 months.

Take, for example, the period to the far left of the chart from mid-2014 to early-2015, in which the dollar rose from 80 to 100.5 within eight months. It is entirely conceivable that in a precipitous dollar decline, the greenback could return just as quickly to the 79-80 region over a similar time frame. This would equate to nearly a 15% further drop in just a year.

Long-Term U.S. Dollar Indicator

Consider our monthly momentum indicator for the dollar, dating back to the mid-1980’s. According to this model, the top just seen in the dollar was the most significant of the past 30 years. This registers an even more overbought reading than the 2001-2003 top.

For reference, recall that the decline which began in the dollar in 2001 at 118 on the index coincided with the all-time low in gold at $255 per ounce.

US Dollar Index Monthly

Consider, too, that the decline which followed the 2001 top resulted in over a 40% loss in the value of the U.S. dollar in just six years. Were such a percentage decline to occur again from this greater-magnitude signal, the target would be 62 on the index by 2023. Or of the Y-axis below the chart.

Metals Have Not Responded to USD Weakness… Yet

Of course, what remains to be seen is: when do gold and silver begin to respond to the U.S. dollar’s decline? From 2003 – 2008, there was a strong day-to-day inverse correlation between the dollar and gold. Recently, however, precious metals traders have been largely ignoring the bulk of the decline in the US dollar up to this point.

When will traders begin to notice the decline in the world’s reserve currency? We cannot say for certain. However, we will begin to pick up the change in behavior when it registers on the charts. We should begin to see $10 – $20 spikes in gold on specific days when the dollar falls by 0.5% – 1.0% on the index.

Whichever form the pending bounce takes will tell us much about the strength or lack thereof for the dollar to be expected over the next several years.

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. He specialized in the creation and interpretation of pattern-of-life mapping in Afghanistan and Iraq.

Technical analysis shares many similarities with mapping. Both are based 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. As well as short-term opportunities for profit.

This article is provided as a third party analysis and does not necessarily matches views of Bullion Exchanges and should not be considered as financial advice in any way.


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