WEAKER DOLLAR BOOSTS GOLD -- YIELD CURVE WIDENS A BIT -- WILL THE FED PAUSE?
GOLD JUMPS SHARPLY AS DOLLAR FALLS ... Yesterday I showed the Gold ETF (GLD) and the Gold (XAU) Index stabilizing at their moving average lines, and suggested that both were starting to benefit from a falling dollar. With the dollar falling even further today, gold prices have gained more than $9.00 and gold shares are up 3.5%. The upside gap on the GLD (Chart 1), coming three days after Monday's downside gap, has created an "island reversal" pattern which is usually bullish. [An island is caused when a downside gap is followed shortly by an upside gap. The result is a few isolated price bars surrounded by gaps]. The GLD is now headed for another challenge of its March/August highs near $446. An upside breakout would be a bullish development. The XAU Index in Chart 2 found new support at the broken resistance line extending back to last December and its two moving average lines. The XAU/SPX relative strength ratio has broken a resistance line as well. Gold stocks were one of August's strongest industry groups. I've suggested before that part of the gold rally was based on expectations for a weaker dollar. Part of the reason that the dollar is rolling over may have to do with expectations that the Fed may pause in its rate hiking.
Chart 1
Chart 2
YIELD CURVE WIDENS ON BELIEF FED WILL STOP TIGHTENING... I wrote a story yesterday about how a flattening yield curve was hinting at economic weakness and was hurting bank stocks in particular. A flattening yield curve happens when short-term rates rise (because of the Fed) and long-term rates fall. That's been happening for over a year now. The danger is that short-term rates may move higher than long-term rates which would cause an "inverted" yield curve. In the past, an inverted yield curve has usually led to an economic contraction or recession. Hurricane Katrina may have changed things. Although long-term rates dropped sharply this week in its wake, short-term rates have dropped even further. The reason for that is the market's belief that the threat of economic damage from the hurricane may prompt the Fed to halt its tightening campaign. That's where the dollar comes in. The Fed has been the only central bank that's been raising rates and that's helped support the dollar rally. If the Fed stops raising rates, the dollar will probably drop. I've written before that gold is a rate-sensitive commodity. Lower U.S. rates lead to a lower dollar and higher gold prices. The belief that the yield curve may start to widen explains why bank stocks (and financials in general) are rallying so strongly today (Charts 3 and 4). The belief that the Fed may stop raising rates may also explain why the market bounced impressively yesterday on rising volume.
Chart 3
Chart 4
