GOLD SURGES AND TURNS VOLATILE -- EURO REMAINS WEAK OVERALL -- TIPS AND GOLD MOVE IN TANDEM -- RISING INTEREST RATES BOOST THE DOLLAR -- STRONG DOLLAR KEEPS OIL IN CHECK - INTERMARKET PICTURE SINCE MID DECEMBER

GOLD AND THE EURO DIVERGE ... Today's Market Message was written by Arthur Hill. - Editor

Contrary to historical tendencies, gold and the Euro appear to be going their separate ways. There has historically been a negative correlation between the U.S. Dollar and gold. The Dollar advances as gold declines and visa versa. Taking this one step further, this suggests a positive correlation between the Euro and gold. Chart 1 shows 5-day SMAs for the streetTRACKS Gold ETF (GLD) and the Euro Trust ETF (FXE) over the last 20 months. From June-2007 until late December-2008, there was clearly a positive correlation between these two. Both advanced from Jun-07 to Mar-08, both declined from Jul-08 to Nov-08 and both advanced from Nov-08 to late Dec-08. Things changed significantly in late December. Even though the Euro Trust ETF moved sharply lower from late December until early February, the streetTRACKS Gold ETF continued moving higher (yellow area). This new relationship suggests that some Euro sellers are turning to gold instead of the Dollar.

Chart 1

GOLD SURGES AND TURNS VOLATILE... The streetTRACKS Gold ETF (GLD) surged back above $90 in morning trading on Thursday, but fell back in early afternoon trading. Volatility remains high across the broad so I will focus on the bigger chart patterns at work. In fact, with volatility high in just about everything, this is pretty much a good idea in general. Take a step back and look at the bigger picture. Gold has been leading the way higher over the last few months. Today's early surge simply reinforces the bigger uptrends. Chart 2 shows daily bars over the last 6 months. GLD broke resistance around 85-87 and this breakout held (orange area). Broken resistance turns into support now. The bullion bulls are in good shape as long as GLD holds above 85. Chart 3 shows weekly prices with a big channel breakout three weeks ago. Even though GLD is getting some resistance from the Sep-Oct highs in the low 90s, this breakout is clearly holding and has yet to be proven otherwise.

Chart 2

Chart 3

GOLD AND TIPS HINT AT INFLATION... In the 23-Jan Market Message, John Murphy suggested that gold could be rallying because of an increase in inflation expectations. TARP money, monetary stimulus and the fiscal stimulus package are all designed to pump up the economy. In a nutshell, the government is throwing money at the problem and this could be inflationary down the road. Chart 4 shows the streetTRACKS Gold ETF (GLD) with the iShares Inflation-indexed Bond ETF (TIP). As the name implies, these bonds are designed to protect returns in an inflationary environment. Therefore, demand for these bonds will increase as inflation expectations increase. The positive correlation between these inflation-indexed bonds and gold is amazing. In large part, these two have risen and fallen in tandem over the last 20 months. Chart 5 shows the streetTRACKS Gold ETF with the iShares 20+Yr T-Bond ETF (TLT). It is tough to define the correlation here. Normal bonds, like TLT, loathe inflation. The recent surge in gold and the iShares Inflation-indexed Bond ETF could be weighing on normal bonds.

Chart 4

Chart 5

EURO REMAINS UNDER PRESSURE... The European Central Bank (ECB) met today and left their benchmark rate at 2%, which is significantly higher than the Fed Funds rate. With the Fed Funds rate at .25%, the Fed essentially has a zero percent interest rate policy to combat deflation, the financial crisis and the economic slow down. Even though the ECB faces similar problems, it has been much slower to cut rates. This could be putting downward pressure on the Euro for three reasons. First, the ECB appears to be behind the curve. Two, the slow response from the ECB could hinder economic growth in the Euro zone. Three, currency traders expect further rate reductions from the ECB, which holds its next meeting in early March. Chart 6 shows the Euro Trust ETF (FXE) in a steep decline since mid December. Support from the November lows is near, but there is no sign of material strength. This is a close-only line chart. It would take a close above 132.5 to break the December trendline and reverse the downtrend.

Chart 6

RISING RATES LIFT THE DOLLAR... Even though the Fed is unlikely to raise interest rates anytime soon, the 10-Year Note Yield ($TNX) has been rising since late December. Chart 7 shows the 10-Year Note Yield ($TNX) over the last 2 1/2 years. Long-term rates broke support at 3.25% (32.5) and plunged in November-December. After firming in mid December, the 10-Year Note Yield surged over the last six weeks and is nearing resistance from broken support. Chart 8 shows the 10-Year Note Yield with the US Dollar Index Bullish ETF (UUP) over the last 20 months. Except for the Jul-Nov surge in the Dollar, there appears to be a positive correlation between the two. Notice how UUP fell sharply when rates fell sharply (mid-November to mid-December). UUP suddenly recovered when the 10-Year Note Yield moved higher over the last six weeks. Higher yields make Dollar denominated bonds more attractive. This relationship bears watching as we head into the employment report on Friday. A sharp decline in rates (rise in bonds) could weigh on the Dollar.

Chart 7

Chart 8

Chart 9

STRONG DOLLAR KEEPS OIL DOWN ... Continued strength in the greenback partly explains weakness in the United States Oil Fund ETF (USO). In addition, the Energy Department reported a jump in crude inventories on Wednesday. This suggests that weak demand is pushing oil into storage, which means a supply overhang. Chart 10 shows USO waffling near support from the late December low. The big trend is clearly down, but there is evidence of support around 28. USO gapped down eight days ago and has yet to recover from this gap. A surge that fills this gap would be the first step toward affirming support. We could even entertain the idea of a double bottom if USO surges off support. Barring such a surge, the bears remain in full control. Watch for strength in the stock market and weakness in the Dollar to possibly benefit oil. So far, these two are not helping oil.

Chart 10

INTER-MARKET PERFCHART... Perfchart 11 shows the performance of eight inter-market related items since mid December. I chose mid December because this is when the Euro peaked, the Dollar bottomed, oil peaked, bonds peaked and rates bottomed. Mid December seems mark an inflection point of sorts. Even though oil extended its decline, perhaps this was the moment the market started focusing on inflation.

Chart 11