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As Gold Booms, the Dollar Will Bust

By Sean Hyman   |   Wednesday, 18 Feb 2009 09:06 AM

One thing that has always helped me trade currencies through the years is that I watch every major market and not just the currency I’m trading. There are things in other markets that tip me off to something that will happen in the currency market.

Recently, I’ve seen something coming that will eventually weigh down on the U.S. dollar. It's the recent breakout in gold prices.

In 2008, most commodities fell very hard and the dollar rallied against them. Yet, in late January something happened that hasn’t happened in over eight months. Gold broke out to the upside once again.

What does this have to do with the dollar? Since gold and other commodities are priced in dollars, it tends to make them trade opposite of each other over long periods of time.

However, right now, both gold and the dollar are rising. But, that can’t last forever. Historically, there are short periods of time when the two can rise or fall together, but it’s not long before they have to part ways again.

We are in one of those periods right now.

The environment has been right for a gold breakout: politicians scratching their heads, economic woes, interest rates near zero, a slump in gold production in South Africa, a bond bubble that’s starting to burst, among others.

So where is money to go in these troubled times, especially with Treasurys being so overbought right now? The next logical place for money to flow into is gold.

Even when the global economy begins to rebound, money won't flow out of gold because at that point, global growth will start to reemerge and inflation will finally be back. Once that happens, gold will take back its role of being an inflation hedge.

This breakout in gold has legs and can go for quite some time. It won’t be long before we see it top $1,000 an ounce and head into all-time highs.

When this happens, it will be like an ankle weight around the dollar. It will weigh the dollar down and make it harder for it to ascend. When this takes place, you will see other foreign currencies like the euro and Aussie dollar start to rise as the dollar begins to plummet.

The euro is the biggest “anti-dollar.” When money starts to flow away from the buck, it typically first heads for the euro. There are many reasons for this, but one of the biggest is because once you leave the pool of liquidity of the U.S. markets, the next most liquid markets are those in Europe. Therefore money is exchanged from dollars to euros so that it can participate in that market.

The big money out there needs huge pools of liquidity to work with so that it can move in and out of financial assets without moving the market on themselves. That’s why the euro will be one of them.

As for the Aussie dollar, Australians are huge gold miners and exporters. As gold prices rise, so do the profit margins of these gold miners, so it helps the Australian economy out.

Another reason is because Australia has been one of the countries that has been the most unscathed by the global slowdown. Sure they’ve had their woes, too. But if I had to pick who was the worst in the ugliest economy contest, my choice would not be Australia.

Another thing that Australia has on its side is that China’s economy is starting to show the beginning signs of a recovery. It’s only in its early stages, but once China does better so does Australia because China is one of their biggest customers.

Therefore, this will all help the EUR/USD and AUD/USD pairs in the spot forex market. It will also help exchange-traded funds such as FXE and FXA. So these are things that both the currency and stock investor needs to watch out for.

Watch out for the signs of gold weakening the dollar. Once this starts to take effect, the euro and Aussie dollar will both benefit from the fall of the dollar once again.

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One thing that has always helped me trade currencies through the years is that I watch every major market and not just the currency I’m trading. There are things in other markets that tip me off to something that will happen in the currency market. Recently, I’ve seen...
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