In last week’s market report, titled Gold: Calm Before the Storm, we noted that there was a good chance gold prices would soon move sharply, with the non-farm payroll report a potential catalyst.

The headline figure, which suggested 295,000 jobs were created in the USA, blew away market expectations, and saw gold prices sink the better part of USD $40oz.

We must admit to being surprised by the strength of the print, if only because so many headline data releases (factory orders, construction etc) had been weak leading in, but these things are always a lottery. Either way, given the strength in the headline print, the market reaction in gold wasn’t surprising.

The market closed the week off around the USD $1160oz mark, giving up all of the gains we’d seen so far in 2015 in the process. The weakness has persisted throughout this week, with gold prices trading today at just USD $1155oz, with silver also now back below USD $16oz as well.

Australian dollar gold was originally supported by the weakness in the local currency, though it has now fought back somewhat, trading at 0.77 vs. the USD. The end result is that AUD gold is now trading at almost exactly $1500oz, with silver sitting just above $20oz.

No matter which way you look at it, it was another win for the gold bears, with the market again breaking out of a key trading range to the south.

Further evidence that we’re not totally out of the woods in this cyclical correction, and that dollar cost averaging is the best approach to take with this market.

King Dollar

The recent weakness in gold has been all about the USD. Over the past few several months, the USD has been skyrocketing, with the Euro in particular, as well as the Australian Dollar and a range of other currencies under serious pressure.

As it stands today, the US Dollar index has climbed all the way to almost 100, an over 30% rally on where it was back in 2011, a large part of which has occurred in just past the few months.

The chart below captures this move and what has happened to the US Dollar index since 2010.

You can see the almost parabolic rise in the index since the middle of 2014.

Be you in any doubt about how significant this move has been, especially in the last couple of weeks, consider the following screen grab which came via Bloomberg this week, all of which express various currency movements vs. the US Dollar.

In short, the dollar strength of late has been crushing every other currency in its wake, and as gold is another form of money, it too has been hit.

In light of the strength in the dollar of late, one could actually make an argument that gold is holding up relatively well. The fact that it is only down a few per-cent since the end of 2013, when most currencies have been crushed vs. the USD is evidence of this.

As for what happens next, the following chart is worth paying attention too.

It plots the USD gold price on the right hand scale, and the US$ and its trade weighted index on the left hand side. The dollar is inverted though, so a decline purple line reflects a stronger USD.

As you can see, looked at in this light, gold has actually held up very well. It sold off in 2013 when the dollar first started strengthening, but in the last year or so, it’s held its own, whilst the dollar continued surging higher.

As for what happens, which is really the most important thing, this chart is telling us one of two things.

The first potential conclusion is that gold prices could have a fair bit further to fall, so that they ‘catch down’ to the US Dollar. This would fit in with the deflationary, capitulation sale theory that some have for the gold market, many of whom see it ultimately bottoming out around USD $950oz.

That kind of market action probably takes place with the Australian dollar below US $0.70. Were the USD gold price to hit that level, with the Aussie trading at US $0.70, it would imply a AUD gold price of $1357, within 10% of where we are today, whilst a AUD of just 0.65 vs. the USD puts local gold prices at $1460, within 3% of where we are today.

As bullish as I remain long-term on gold, if one was forced to bet, this would be the consensus trade.

The alternative interpretation from looking at the above gold vs. US dollar graph is that the gold price is telling us something, most likely that

• The Federal Reserve won’t be able to normalise interest rates anytime soon like some in the market are expecting

• The US economy is slowing down, and will need more monetary stimulus itself.

As such, the gold price could be holding up relatively well, as it can often be seen as a leading indicator of a change in market circumstances. On this note, it should be said that the gold price crash of 2013 was a leading indicator of declining inflation and the bloodbath in commodities (think oil), that occurred 12 months or so later.

Arguments suggesting that the has been increased weakness in the US economy of late are gaining strength too, with overnight retail sales missing expectations by a long margin. Coming in at -0.6%, vs. expectations of a gain of 0.3%, they represented the third month in a row that sales figures have fallen, one of the worst runs since the GFC hit.

Apart from the headline beating payrolls numbers, this represents another disappointing data release for the US economy, with a slowdown in growth almost certain. To that end, even the Atlanta Federal Reserve are now predicting that Q1 GDP will come in at just 0.6%, vs. expectations of closer to 2% growth a few weeks back. If their new estimate is anywhere near accurate, it will be a huge decrease in the rate of growth the US economy is experiencing.

Couple with almost record low official CPI readings, it would place huge pressure on the Federal Reserve to delay any thought of rate hikes, potentially pushing them to 2016.

This could potentially take some heat out of the USD, and spark some demand for precious metals – both gold and silver.

Before, finishing up our look at gold and currencies, let’s take a quick look at the USD from a tech perspective – with thanks again to colleague John Feeney

Technical Look

The US dollar continues its amazing rally as the talk of heightened rates in the US continues. This is a large contributing factor for the lower US gold price over the past few months. The weekly chart can be seen below and really highlights when to use and when not to use certain technical indicators. The RSI and Williams % oscillator have been signalling overbought levels since mid 2014.

A good example of how these indicators can largely be ignored in a strong uptrend or downtrend, and better to use the MACD in a strong up/down trend to pick a top or a bottom.

From my point of view, I wouldn’t want to go short the USD into the face of such buying strength, but i’d also be nervous going long here too. It's true that the trend can be your friend, but that has been quite some rally of late.

Mainstream Economics

Anyone who regularly reads these market reports would know that we often disagree with more conventional economic thinking. We saw another example of this earlier in the week, with the following comments catching our eye.

According to this gentleman, the fact that there is downward pressure on inflation is not a good thing for consumers. The fact that the value of their dollars is being preserved/maintained is apparently a bad thing, and it would be better for them if their money was devalued faster, through higher inflation.

We simply can’t agree with this line of thinking, and struggle to marry it with what we believe is a common sense way of thinking, namely that it is better when our dollars go further, and they can purchase us more, not less.

Over the long run, this is going to have major implications for investors, for this mainstream thinking, that more inflation is not only necessary, but a good thing, will continue to dominate policy makers thinking.

Whilst their might not be much official inflation today, we have no doubt that it is coming, and it’s best to prepare for it now.

A final word on Australia

Before we finish this weeks market report, it’s worth pointing out that whilst this weeks employment report was in line with expectations, we did see the participation rate continue to fall. We’ve also seen weaker consumer and especially business confidence, with more confirmation that their will be no major investment coming from corporates in the immediate future.

With China slowing, and downgrading their growth forecasts, we’ve long been warning of a potential recession here, and the near certainty that interest rates would head toward 1.5% or lower, something mainstream economists only belatedly acknowledged earlier this years, when the RBA “shocked” the nation with a 0.25% interest rate cut.

As for how dependant we’ve now become on China, and our exports of resources there, consider that they now consume over 30% our export market. In terms of what we export, this chart below shows the breakdown today, and how that’s evolved compared to the late 70’s and early 90s

For those wanting a more detailed read on the subject, you can do so by clicking here.

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness. This report was produced in conjunction with ABC Bullion NSW.