US DOLLAR IS THREATENING LONG-TERM SUPPORT WHILE XAU INDEX IS CHALLENGING ITS OLD HIGH -- GOLD NEARS TEST OF 2006 HIGH

DOLLAR IS SITTING ON BIG PRECIPICE ... The U.S. Dollar has been weighed down recently by the sharp drop in U.S. interest rates and the near certainty that the Fed will lower the Fed funds rate next week. That puts the greenback at a very dangerous point. Yesterday's close for the U.S. Dollar Index (which measures the dollar against six foreign currencies) closed below 80 (79.86 to be exact) for the first time in fifteen years. Chart 1 shows the USD trading below its 2004, 1995, and 1991 lows at 80. The last vestige of possible support is the 1992 low at 78.43. So far, the downside violation of previous support at 80 is relatively minor. But the dollar situation is worth paying attention to. For one thing, a record low in the dollar would push foreign currencies higher. [The Euro is close to setting a new record high]. It would make foreign stocks more attractive than U.S. stocks. It would also favor large caps over small caps (since large caps have more international exposure). The most direct result, however, would be higher commodity prices -- and gold assets in particular.

Chart 1

XAU INDEX NEARS RECORD HIGH ... Chart 2 compares the Gold & Silver (XAU) Index (gold line) to the Dollar Index (green line) over the last twenty years. One obvious observation is that the two lines usually trend in the opposite direction. Notice, for example,, that the last major upturn in the XAU during 2002 started with a major peak in the USD. The chart also shows the XAU challenging its previous highs hit in 1990 and 1987. The main message of the chart is that a new record low in the Dollar Index would most likely produce a new record high in the XAU. Dollar weakness also helps explain the recent upside breakout in gold itself.

Chart 2

GOLD ETF NEARS 2006 HIGH ... Markets have a way of anticipating things. It looks like last week's upside breakout in gold itself was in acticipation of more dollar weakness. In any event, the point & figure boxes in Chart 3 (plotted through yesterday) show gold trading over $700 for the first time in more than a year. Today's gain of nearly $10 puts bullion within $10 of its 2006 high at $730. The irony of this is that the Fed may be forced to put its anti-inflation vigilance aside to deal with the possibility of a slowing economy. A Fed easing could weaken the dollar even further and boost commodity markets. Higher commodity prices may force the Fed to deal with inflation again at a later point in time.

Chart 3