Dollar's Small Rally and Silver's Big Decline – Which of Them Is Bullish for Gold?

This essay is based on the Premium Update posted on August 13rd, 2010

Two weeks ago, we've posted an essay in which we've analyzed i.a. the Euro Index. We've stressed that a slight move lower may be seen in the short-term, which will likely be coupled with a corresponding move higher in the USD Index. This is precisely what we have just witnessed, so without further introduction, we will let you know how low can it take the Euro Index and how big rally could we see in the USD Index. In the latter part of the essay we will provide you with our very-long-term silver chart.


Let's start with the long-term Euro Index chart (charts courtesy by http://stockcharts.com.)

We must begin this week's technical analysis section with a comment on the long-awaited correction, which alas is clearly seen in the week's long-term Euro Index chart. After a move above a key resistance level, confirmation did not occur, and subsequent days saw a decline below this level.

In last week's Premium Update, caution was suggested and a period of consolidation was termed likely. "For the short-term we remain skeptical towards a continuation of the rally in the Euro Index until we see confirmation for a breakout or consolidation. The latter still appears more probable."

Once again, applying hard and fast rules as part of our technical analysis and interpretation resulted in the right call rather than unwarranted optimism. The reason for this comment is that we would like to emphasize the need to wait for a confirmation instead of chasing the market.

The short-term Euro Index chart this week provides a clearer picture of the correction we mentioned above. Note that the RSI has moved below the 50 level and the Euro Index itself is very close to the first Fibonacci retracement level which is based upon the previous rally. The long-term declining resistance level will now likely become a support, as it intersects with the key 61.8% Fibonacci retracement.

This means that there is a strong possibility that the euro will decline again in roughly the same amount as we have already seen. This will result in a target bottom, slightly below or at the 125 level. At this time, it does not seem likely that the bottom will move to levels seen last June, but we surely can't rule that out completely. Indications are that 125 is an accurate minimum target for the current decline. This seems to be about 50% likely with a 25% chance that the bottom will be above 125 and a 25% chance for moving below this level.

In this week's long-term USD Index chart, we see a slight rally, which was expected in view of the Euro Index decline. This is consistent with what we stated in last week's Premium Update. We identified a possible profit opportunity for FOREX traders with a rise in the dollar likely. This turned out to be right on the money.

From a precious metals perspective, there is little to be said at this time. The impact of the currency markets this week has been minimal, yet positive. However, it is still possible that gold and silver will move higher in the next few days only to move lower once again afterwards. Additionally, it is still likely that the precious metals sector would decline towards the end of August.

In the recent past, gold, silver, and mining stocks declined slightly when the USD Index showed a strong rally. This was followed by a consolidation for the USD, which coincided with a precious metals rally. All in all, the precious metals sector has shown strength in relation to the dollar.

Let's take a look at the short-term chart for more details.

In this week's short-term chart, we see a higher, broader and bigger target for the short-term rally in the USD Index. The strong momentum seen recently has been surprising and our prior target range has already been reached. It is possible that the USD Index could move as high as 84 and its next turning point may be seen relatively soon. A top in the USD index could correspond to one for precious metals as well.

Other than the above, the relationship between gold, silver and mining stocks and the dollar remains unclear at this time. Turning points may coincide, but it is a situation, which must be continuously monitored. As always, Sunshine Profits will be up to the task.

Before summarizing, let's take a look at the big picture regarding the silver market – since both metals usually move together the below analysis should prove useful to gold Investors as well.

On the very-long-term chart this week, emphasis is given to the TRIX indicator, which has declined somewhat in the past weeks. This is a bullish signal for the long-term as important developments usually occur after the TRIX reaches zero. There is a possibility that this level may be reached in the relative near-term, possible once we've seen the end of the summer decline that we've described in the full version of this essay.

A sharp decline in silver's price could cause a substantial decline in the TRIX, which would be a healthy and normal development for the market. The coming decline might appear scary at the first sight, but if it does materialize – please keep in mind that it's something that will allow the market to move even higher in the long run.

Previous "second" rallies for the white metal have often been followed by declines after silver failed to move above previous highs. After that we've used to see corrections that took silver much lower – correcting 50% of the preceding rally. Silver may or may not get this low in its next decline.

The current retracement level is based on the 2008 low and the 2010 high. Since the 2008 decline was generally an unordinary development, the $14 target (as visible on the chart above at the 50% retracement) might be too low, and perhaps the $16 level would hold.

Summing up, last week's view for the short term was quite accurate and we now see a possibility of higher USD Index levels in the coming week. The Euro Index will likely decline again in the week ahead, continuing the trend, which took hold during this past week. Precious metals are likely to move slightly higher in the short term but we remain bearish for the next few weeks in advance of an expected late summer low in much of the precious metals sector. Full essay with more details is available to our Subscribers.

Technically, lower silver prices will be healthy not only for silver but also for gold and mining stocks as well. We have seen massive rallies quickly follow severe declines in silver's price. This may, in turn, eventually lead to higher silver prices, possibly the next rally would take silver to $25 – $35 area.

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Thank you for reading. Have a great weekend and profitable week!

P. Radomski