Overbought Gold Signals Pause in Bull Market Trend

By: Ned_W_Schmidt

That the U.S. dollar has serious problems should, by now, be obvious to even economists working for the Obama Regime. We probably cannot say the same for those at the Federal Reserve, for they do not seem to consider such matters important. To those economists such matters are exogenous factors, and not worthy of inclusion in the discussion. Until the dollar’s fatal flaws manifest themselves as headlines, neither group will act to stop the Obama Dollar Devaluation. As Gold Bugs have learned, though, alternatives to holding the dollar do exist. China and Brazil also recognize this,  having now decided to explore the means of eliminating the dollar from their business dealings. The question of if the dollar “disappears” is being replaced with the question of when it “disappears.”

Readily apparent in the above chart is that the U.S. dollar has broken down. No support exists for it in terms of its value against the world of other currencies. Few traders are willing to grab a “falling knife.” That said, however, expectations of immediate gratification from the dollar’s demise may be somewhat premature. A negative trend for the U.S. dollar is now recognized. However, that trend will unfold with rallies and failures, not in an immediate collapse. A key element of a trend is time.

With the dollar having fallen for nine weeks, an over sold condition has now developed. That is indicated by the blue oscillator in the chart. Currency moves near universally overshoot on the upside  and the downside. For that reason, the short-term movement to the downside may be exaggerated. Some upside reaction to release the tension would be the norm.

Expectations of immediate gratification, therefore, in the $Gold market may be premature. The U.S. dollar’s bear trend will take time to unfold. As that happens, periods of euphoria and disappointment should appear in the markets for both $Gold and the stocks of the producers. Restraint on both actions, and calls for action, on the part of investors might be wise at this time.

Aside from the over sold condition of the U.S. dollar, some fundamental factors may contribute some to the short-term tempering of both the dollar’s collapse and $Gold’s ascension. Aside from lore on the Summer influence on markets, real events, rightly or wrongly, are associated with Summer. As bountiful quantities of carbon dioxide are joyfully generated in backyards, dollar liquidity tends to seasonally unwind.

In the above chart is a red line of circles, using the left axis. That line is the inflationary component of U.S. money supply growth. It uses M-2 and a six month measurement period. The most current plots indicate a slowing in the growth of the  inflationary component of U.S. money supply. That development is consistent with past Summer time experiences. Apparently, some seasonality does exist.

Dollar liquidity, despite the best efforts of the Federal Reserve, is declining. That action should, in the short-term, bolster the dollar somewhat. Further, that lowering of liquidity growth tends to dampen the action in $Gold. 

But note, this lowering of dollar liquidity growth is not a permanent situation. With the Federal Reserve throwing vast quantities of credit at the system, a turn in this liquidity growth can be expected. Seasonally, it has happened as Fall approaches. 

Also, in that chart are buy signals for $Gold created from the action of the inflationary component of U.S. money supply growth. Those buy signals occur when the rate of change in the inflationary component of U.S. money supply growth is negative, and then turns positive. Think of that as equivalent of someone stepping on the U.S. monetary “gas pedal.” Those buy signals are indicated by black triangles. 

One of those black triangles, that one on the far right, is a projected buy signal. It has not occurred yet. Using the past experience, and acknowledging the wild eyed nature of U.S. monetary policy, a projection can be made for the next buy signal. It is projected for September.

A further short-term concern is the over bought nature of $Gold, and the persistence of that characteristic. The black line in the above chart is an oscillator designed to measure “enthusiasm” in the $Gold market. When over bought, it gives “Do Not Buy” signals. Reason for that is that we never sell in a bull market. Reverse of that is that we never buy in a bear market.

In particular, we note the similarity between the oscillator’s pattern during this period and the period before the last period of weakness in the price of $Gold. Those patterns are marked by bright colored boxes. Will it repeat? Perhaps. The persistent high level of enthusiasm, and expectations of immediate gratification, do raise some caution flags, Or if you prefer, blue triangles.

What should a $Gold investor being doing now? First, hold your Gold. Second, build cash for any period of price weakness that might develop this Summer. Now would be a good time to review holdings of paper equities, selling any inappropriate ones that have benefitted from the most recent bear market rally. Hold that cash in a suitable vehicle with which to later buy $Gold. Non U.S. dollar investors should be using any weakness in the price of Gold brought on by the recent rally in non dollar currencies to add to holdings. One need only look about at the leadership failures in current U.S. and U.K. governments to realize that Gold should indeed be in your portfolio.

By Ned W Schmidt CFA, CEBS

Copyright © 2009 Ned W. Schmidt - All Rights Reserved

GOLD THOUGHTS come from Ned W. Schmidt,CFA,CEBS, publisher of The Value View Gold Report , monthly, and Trading Thoughts , weekly. To receive copies of recent reports, go to http://home.att.net/~nwschmidt/Order_Gold_GETVVGR.html

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