TWO-YEAR LOW IN THE DOLLAR CONTRIBUTES TO UPSIDE BREAKOUT IN GOLD -- GOLD IS OUTPERFORMING STOCKS FOR THE FIRST TIME SINCE 2011 -- BUT NOT ENOUGH TO POSE A SERIOUS THREAT TO STOCKS -- RISING EURO IS HURTING STOXX 50
GOLD ACHIEVES BULLISH BREAKOUT ... After trading sideways for the past five months, gold finally achieved a bullish breakout yesterday. Chart 1 shows the price of gold breaking the $1300 barrier which had turned back previous rallies in April and early June. Gold is adding to that gain today. The flight to gold is being blamed on renewed global tensions following North Korea's firing a missile over Japan yesterday. And that is certainly playing in role in the flight into safe havens like gold, bonds, and the yen. But there's more going on beneath the surface that's supportive to gold. One is a drop in the U.S. Dollar Index to the lowest level in two years. A falling dollar is good for gold. So is the drop in global bond yields. Part of that is the result of a flight into bonds as stocks weaken. But there are other factors. Disappointment at the failure of Janet Yellen and Mario Draghi to address monetary policy at Jackson Hole last week pushed Treasury yields lower along with the dollar. A rally in the Euro to the highest level in two years also reduces the odds for a more hawkish ECB. That's also good for gold. So is summer weakness in stocks and a rise in volatility. Gold is outperforming stocks for the first time since 2011 (more on that shortly). But let's start with the falling dollar.
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Chart 1
DOLLAR INDEX FALLS TO TWO-YEAR LOW... Chart 2 shows the U.S. Dollar index (green line) trending in the opposite direction of gold over the last five years. Upturns in the USD in the spring of 2014 and the second half of 2016 pushed gold lower (see arrows). Since the start of 2017, however, a -10% drop in the dollar has helped produce a 14% gain in gold. And yesterday's upside breakout in gold coincided with a drop in the USD below its 2016 low to the weakest level in more than two years (green circle). So a breakdown in the USD contributed to an upside breakout in gold. Chart 2 also puts this week's breakout in gold in better perspective. Although gold is trading at the highest level this year, it still hasn't achieved a major breakout. To accomplish that, gold would need to clear the "neckline" drawn over its early 2014/ mid-2016 highs. To do that, it would need the dollar to keep dropping and interest rates to stay low. A major upside breakout in gold wouldn't be good for stocks.
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Chart 2
GOLD IS RISING FASTER THAN STOCKS ... Gold is doing better than stocks this year. The bars in Chart 3 show a ratio of gold divided by the S&P 500 (through yesterday) rising to the highest level since April. Gold has risen more than 14% this year versus a 9% gain in the S&P 500. That's the first time that's happened since 2011 when stocks lost nearly 20% at one point before recovering. Chart 4, however, puts the gold/SPX ratio in better perspective. The chart shows that the last upturn in the gold/SPX ratio took place at the start of 2016 when stocks were also under pressure. The bottom in the S&P 500 in February 2016, however, coincided with a peak in the gold/SPX ratio (see circles). The falling ratio supported rising stocks until this summer when it started rising again. The good news is that the rise in the ratio is still relatively small and doesn't appear to pose a major threat to stocks. For that to happen, the ratio would have to exceed its April peak. In addition to a weak dollar and low interest rates, gold usually needs a weak stock market to thrive. Right now, it doesn't have that. But some traders are starting to hedge their bets against the aging bull market. The fact that gold miners are doing even better than gold this year is another positive sign for bullion.
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Chart 3
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Chart 4
RISING EURO IS HURTING EUROZONE STOCKS... The flip side of the falling dollar is the rising Euro which has reached the highest level since the start of 2015. The rising currency, however, is taking a toll on eurozone stocks. The blue bars in Chart 5 show the STOXX 50 Index peaking in May and losing more than 7% since then. It's down again today. [The STOXX 50 includes the 50 largest and most liquid stocks in the eurozone]. Chart 5 also shows it trading below its 200-day average for the first time since last November. That's not an encouraging sign. Which is why the ECB must be concerned about the negative impact a rising euro can have on eurozone stocks and the economy. Not to mention the dampening effect of a rising euro on inflation which is stubbornly low. That explains why the ECB has to tread very carefully to not sound hawkish on monetary policy. [That's another point in gold's favor]. There's a silver lining, however, for American investors who trade MSCI Eurozone iShares (EZU). Chart 6 shows a ratio of the EZU divided by the STOXX 50 rising sharply this year. [The EZU has gained 23% this year while the STOXX 50 index is flat for the year]. That's due to the simple fact that the EZU is traded in weaker dollars, while the STOXX 50 is quoted in a stronger euro.
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Chart 5
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Chart 6
STOCK INDEXES ARE STABILIZING AFTER MORNING SELLOFF... After an early selloff, major U.S. stock indexes are stabilizing at mid-day. Chart 7 shows Dow Jones Industrial Average holding above its 50-day moving average. Chart 8 shows the Nasdaq Composite also trying to hold its 50-day line. The Nasdaq is being supported by biotech and technology stocks. Chart 9 shows the S&P 500 still trading below its 50-day line but well above its early July low. None of them have sustained much chart damage during August. One that did is looking better. Chart 10 shows the Russell 2000 Small Cap Index trying to regain its 200-day average after bouncing off its May low. A lot of chartists (including myself) have expressed concern about relative weakness in small caps. Any hint of a recovery there could relieve pressure on the rest of the market.
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Chart 7
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Chart 8
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Chart 9
