Trading Gold in the Face of a Strong Dollar

This week’s trading recommendation focuses on the highly volatile precious metals markets. After peaking 2 weeks ago, gold is more than $60 below its peak, and silver is off an astounding 30%.

We believe gold is an attractive buy at these levels, and silver may start rallying soon as well. The following chart (click to enlarge image) shows the price of gold.

As can be seen from the dashed light blue line, the uptrend in gold drawn from the January low is still intact, and is in fact being healthily followed by the 50 day moving average. As gold is not very far from the moving averages, it appears to be ready to rally, an assertion buttressed by the measurement of gold’s relative strength indicator at exactly neutral levels.

This week saw fundamentals for gold actually improve somewhat. The Producer Price Index as well as the Import Price Index both came in considerably higher than expectations. At the same time, economic fundamentals saw an extension of the same gradual improvement we’ve become used to recently. Both of these signs are bullish for gold, as they indicate increasing inflation, as well as an expanding economy that will also contribute to the velocity of money increasing, thereby stoking inflation even more.

However, the dollar index has continued its recent strength this weak, rallying 4% since May 9th. A 4% move in the index is a large one, and the sudden strengthening of the dollar had the predictable effect of weakening commodities.

Despite the dollar’s strength, we believe gold will and can rally in the face of a rising dollar index. The reason why is that the purchase of gold is not a domestic story, it is an international story of unsustainable debt levels from Europe to Japan to the US. As the dollar index rally becomes more gradual (we believe it will continue as the euro continues to fall), commodities should be able to regain their footing even with a rising dollar.

Trade Recommendation

We recommend the purchase of gold futures in the 1485-1495 level. After selling off aggressively during the commodity meltdown on May 5th and hitting a low of $1462/ounce, gold has continued to sell off, but has reached a slightly higher bottom each time it has sold off. This indicates demand for gold is picking up when it falls, and that the downside is limited. We would view the downside of gold as being limited to the 50 day moving average at $1464.

The same trade can be effected by the purchase of GLD.

Disclosure: I am long gold futures