The Buck Stops Here

The chart of the US Dollar Index is familiar to readers of these alerts. I have presented it many times, most recently on April 4th. Here's the important part from that alert describing the two trading patterns that were evident on the chart of the Dollar Index - the first was a sideways trading range, and the second was a 'flag':

"We can see that the parallel green lines marked A, B and C show a consolidation pattern in the dollar's ongoing bear market. Each of these patterns is identical.

The two orange flags are also identical. They typically trace out bear market rallies. The flag marked #1 clearly delineates a bear market rally that the dollar experienced last year."

After asking which of two paths the dollar would take, I then went on to make clear the implications for the dollar.

At the moment, it is uncertain which pattern the dollar will follow. Will it be 2 or C? We should know within the next week or so. My expectation is that the dollar will follow pattern 2. But regardless whether it is 2 or C, both of these patterns are bearish."

Here is the current chart of the Dollar Index, up-to-date through Friday's closing price. We can see that the dollar has indeed followed pattern no. 2.

This chart is conveying a very important message. The dollar is in a bear market rally. This conclusion is confirmed because we can see from the chart that the dollar is tracing out a trading pattern that is identical to the one it formed in its bear market rally last year - the present pattern no. 2 is identical to last year's pattern no. 1.

This type of 'flag' pattern is typically found in a bear market rally, as last year's experience shows. Will no. 2 also end as a bear market rally? And if so, will the dollar continue to mirror last year's pattern and collapse again just like it did after completing pattern no. 1?

As I am fond of saying, no one knows the future, but we need to answer this question I am posing about the dollar's prospects - will pattern no. 2 also end as a bear market rally? To do this, we have to ask ourselves what underlying fundamentals have changed as the dollar has rallied over the past few weeks that have improved the dollar's situation? In a word, none.

• The federal debt is growing by more than 10% per annum;
• Inflationary pressures continue to mount;
• Shortages of materials - a warning sign of rising inflation - are becoming more numerous;
• Crude oil is continuing its climb toward $40 per barrel;
• The US trade deficit continues at or near record levels and on and on and on.

The only thing good that happened to the dollar over the past few weeks is that it rallied. It is clear that this rally is not based on factors arising from any underlying fundamental improvement in the prospects for the dollar. No, the dollar has rallied because on a short-term basis it was oversold. But as the above chart clearly shows, the long-term downtrend channel (marked by the two parallel red lines) for the dollar remains firmly in place.

The dollar has nearly rallied to the top of the downtrend channel. It therefore seems prudent to expect that 'the buck stops here'. In the absence of any factors that have improved the fundamental outlook for the dollar, there is no other logical conclusion.

More important to the readers of these alerts though is the impact of the dollar's rally on gold. And the answer is not much.

From its low of 84.92 on February 17th, the dollar has now rallied 7.3%. Over this same period gold has dropped -5.0%. From its peak on April 1st to Friday's close, gold has dropped -7.6%, almost identically mirroring the dollar's bounce exactly.

We can see from the following chart that gold has simply retraced back to its 200-day moving average. Gold's long-term uptrend remains firmly in place - in fact, its uptrend is just as firmly in place as is the dollar's long-term downtrend.

It is the nature of markets to become overbought or oversold on a short-term basis. But major trends are not changed by the whims of day traders, scalpers and others who do not care a whit about the long-term big picture.

The major trends for gold and the dollar are clear - up for gold and down for the dollar. These trends will continue until US politicians become more concerned about the dollar's future than the next election, and that's not likely.

Therefore, what would you rather hold? Dollars or gold?

Published by GoldMoney
Copyright © 2004. All rights reserved.
Edited by James Turk

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