Luongo: False Move Down in the Dollar Kills Rally in Gold

One of the hardest things for people wrap their heads around when looking at markets is that for a long-term change in sentiment to occur, the existing status quo must be broken down. In pricing terms that means having to wait while the common wisdom of the market works through its disbelief that conditions underlying the markets have changed.

In the gold community there is a belief that the U.S. dollar is doomed to oblivion and to be replaced with sound money. I’m in that camp, don’t worry. The problem is that most people aren’t. And the belief that central banks have things well in hand, like any other nigh onto religious belief, is hard for people to shake off.

Therefore, it usually takes getting a majority of the market on the wrong side of history, and badly so, before the shift in sentiment, where new secular trends can occur.

Martin Armstrong likes to call this the “false move.” It’s the move up or down that is counter to the larger trend, but which traps a huge percentage of the market short when they should be long and vice versa.

Such is the case with the U.S. dollar right now. There’s a lot of talk about the dollar being replaced as the world’s reserve currency. Every day there’s another headline concerning someone, usually Russia, making a deal to cut the dollar out of a portion of their trade with someone else.

The latest headline is between Russia and the EU setting up the infrastructure to bypass the dollar in energy-related trade. And since Russia does a brisk business in oil and gas with Europe, this is kind of important.

The gold community invariably pounces on this and thinks gold should move up on such news. When it doesn’t, cries of manipulation abound (not that there isn’t) while gold continues to do its thing, moving to its own beat.

The last time I discussed gold I outlined that I thought it was trapped between two powerful forces: the enormous synthetic short against the dollar in the form of foreign-issued dollar-denominated corporate debt (bearish), and an emerging global safe-haven trade because of now $11.7 trillion in negatively-yielding sovereign debt (bullish).

Both of these things are outgrowths of the ongoing political breakdown in the West.

So the day-to-day movements can be hard to parse. After an explosive couple of weeks gold moved to briefly touch $1,360 to end the week before pulling back hard to $1,340. At the same time the euro and the British pound reversed their short-term rallies to continue sinking into oblivion on Brexit-anxiety as Boris Johnson handily won the opening round of the Tory leadership struggle.

The point here is that no one wants a rising dollar. In fact, with the amount of dollar-denominated debt out there, a rising dollar is the death knell for the current global economy. This is why the U.S. Dollar Index keeps flirting with breaking out above 98 but gets rebuffed time and again.

So opportunities to sell from that level will be sharp.

Last week, after the Fed jawboned dovishly and the terrible jobs report was released, the markets still wanted to believe in the weak dollar story. The dollar moved down sharply, testing 96 on the USDX. But events of this week — the attack on oil tankers in the Gulf of Oman — and stronger than expected economic data from the U.S. sent the dollar soaring, gold down $20 and the euro and pound with it to close out the week.

No one wanted to be short the dollar going into the weekend.

It was a simple unwind of a short-term false move down in the dollar and up in the euro and the pound. But at the same time, however, gold continues to knock harder on overhead resistance between $1,360 and $1,375, but was still not able to break through it.

Old habits die as hard as old narratives. There are still too many people who believe in short-term dollar weakness to change their behavior and create the critical mass needed to break out of the current trading ranges.

Theirs is the simple pair trade of long dollar/short gold.  So, some days the safe-haven traders will win out and move gold up and on others those scrambling for dollars will find them waiting in the gold pits ripe for the picking. It’s the way it is.

Until it isn’t.

That said, gold is getting ready to rally in a major way. And until gold gains the market’s confidence alongside the dollar as a safe-haven asset, we’ll continue to watch it be tossed back and forth like insults on Twitter.

We’re not there yet. And if gold doesn’t break through and close above $1,365 on a weekly basis soon, it will likely fall back strong on any hint of the Fed getting hawkish. That, to me, will constitute the perfect false move down to trade against. Because by then the USDX will be flying, the euro sinking below $1.10 and rates finally beginning to rise in European debt held down by the ECB and its destructive policies to keep the narrative of its competence alive.

So as a gold bull, don’t despair if that happens. See the false move for what it is and make the smart trade when it happens.