New trend: Investors are cutting the US dollar to size

The relevance of the US dollar is being questioned as it stayed range-bound despite an equity market selloff, a bond market rally, a commodity price deflation and gold touching all-time highs.

Some of the traditional inter-market connections have broken down recently, making it imperative to take a fresh look at the price action in various asset classes. Usually, when the equity markets fall, the dollar rallies. But this has not happened this time.

In fact, despite the fall in the global equity markets, the dollar has failed to break above its June highs. (See chart above) The equity markets, on the other hand, have fallen far below their June lows. The recent price action in the equity markets and the dollar clearly show that their inverse relationship has been broken.

The other inverse relationship is between gold and the US dollar. Gold has been making new highs, but the dollar index has not made a new low. For instance, the June low on the dollar index was 73.50, which has still not been broken. This shows that the inverse relationship between the greenback and gold is not working. In fact, most commodities, such as copper and oil, sold off in the recent fall, but they did not have an impact on the dollar.

US treasuries too rallied in the past few weeks. This, traditionally, results in a rally of the dollar, as investors seek a safe haven. However, the dollar remained stuck in its range, and this positive correlation, too, did not work.

The price action over the past few days calls into question the relevance of the dollar, which has been at the centre of global asset markets. Price movements over the past few weeks are not enough to write off the dollar. But, after a historic downgrade, snowballing debt, and no serious plan to freeze US government spending, it is not wrong to presume that the past few weeks may be a snapshot of the future.

The chart of the US dollar shows that the greenback is at a level (between 73.50 to 74) where demand exceeds supply. This has resulted in a few rallies in the past. Now that prices have come back to this level multiple times, most of the demand may have been absorbed. The next level of demand is between 72.60 and 73 and prices may head down to that level soon.

Given the break in the inverse relationship between the dollar and equity markets View Chart , we may not see a rally in stocks on the greenback’s breakdown. We may see both assets fall. However, a fall in the dollar may push gold up further, as it is emerging as the safe haven of choice among investors.

However, most crucially, the price action over the next few months will tell us if the dollar is still relevant to asset pricing. From what we see, gold has been a better indicator of equity and commodity market direction. The precious metal is clearly inversely related to equities and commodities for now.

Gold and silver: We anticipated a selloff in gold last week given its massive run-up. Whenever gold has rallied 20 percent above its 30-week moving average, prices have fallen. The first time gold rallied more than 20 percent above the average was in March 2008. It sold off to fall by 34 percent over the next few months.

The second time gold did it again was in December 2009, which led to a correction of 15 percent. Last week, gold again rallied 24 percent higher than the average. However, the selloff has not happened. We feel that gold is bullish, but overbought, and faces the risk of a selloff.

Silver, on the other hand, has resumed its uptrend after falling and consolidating.Silver too had rallied far away from its 30-week moving average by nearly 55 percent before it was pulled down from an overbought situation to neutral. Now, with the excess buyers out of silver, its rising again and may be a safer bet than gold in the short-term. Remember, buyers are future sellers and excess buyers result in excess sellers which is what causes a drop in price.

George Albert is Editor, www.capturetrends.com