Gold Showing Strength

All things being equal, the price of gold will move in the opposite direction of the dollar by the same percentage. In other words, when the dollar rises, the price of gold will decline, and vice versa. To clarify, fluctuations in the price of gold do not affect the dollar. However, the condition of “all things being equal”, does not always exist. Gold can be trading with an intrinsic strength or weakness that is not easily visible at first glance. To help detect such conditions, we can use the GolDollar Index.

GolDollar Index was invented by Tom McClellan (www.mcoscillator.com), and is calculated by multiplying the price of gold by the U.S. Dollar Index. (We divide the result by 10 to keep the numbers from getting too big.) Its purpose is to cancel the effects of currency fluctuations on the price of gold. By comparing it with the spot gold index we can determine if there is inherent strength/weakness in the price of gold.

On the chart below we can see that the dollar has rallied strongly, and the price of gold has drifted downward in response, but it doesn’t appear to be a reciprocal move. By looking at the GolDollar Index, we can see that it has been moving sideways, clearly illustrating that gold has been bucking the trend of the dollar, indicating that sentiment for gold is very bullish.

Another gold sentiment indicator is Central Gold Trust (GTU). It is a closed-end mutual fund, which means that it trades like a stock on the NYSE. The fund owns only gold — the metal, not stocks. Closed-end funds trade based upon the bid and ask, without regard to their net asset value (NAV). Because of this, they can trade at a price that is at a premium or discount to their NAV. By tracking the premium or discount we can get an idea of bullish or bearish sentiment regarding gold.

As you can see, demand for GTU has reached irrational levels, with buyers willing to pay a premium of as much as 25%. That’s nutty, considering that you can buy gold or the gold ETF without paying any premium at all. It does, nevertheless, reflect the very bullish sentiment for gold that is causing the price of gold to resist the undermining effect of the dollar’s strength.

It is not out of the question that gold could actually move higher regardless of what the dollar does. That would be highly unusual, and not something that I would normally expect, especially given the current chart picture for gold. The current intrinsic strength of gold has to do with gold being an asset that has become very attractive as the value of other assets has been evaporating. But the price of gold, like anything else, is not guaranteed not to decline, something to keep in mind when evaluating those radio and TV commercials extolling the invulnerability of gold.

Bottom Line: As long as the dollar remains strong, the price of gold is most likely to decline. While there is strong bullish sentiment for gold, I expect it is only temporary, and not likely to grow to the extent that currency trends are irrelevant.

We rely on our mechanical trend models to determine our market posture. Below is a recent snapshot of our primary trend-following timing model status for the major indexes and sectors we track. Note that we have included the nine Rydex Equal Weight ETF versions of the S&P Spider Sectors. This may seem redundant, but the equal weighted indexes most often do not perform the same as their cap-weighted counterparts, and they provide a way to diversify exposure.

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