Based on the May 27th, 2011 Premium Update. Visit our archives for more gold & silver articles.

We have often discussed how the movement of index level values for both the euro and the dollar mirror each other in a fairly precise manner most of the time. This is mainly due to the euro being the largest component of the USD Index. The currency markets have a great deal of influence on stocks and precious metals alike, so what happens in these markets must be a regular part of any meaningful analysis of trends across the precious metals sector.

A pause is seen in the recent moves of Euro and USD Indices. An expected upside for Euro index and downside for Dollar index would be the litmus for gold moves in the short-term. What could be the implications of currency indices in short-term gold market? Before analyzing the scenario, let’s begin with the recent happenings that influenced gold market sentiment.

The unanimous agreement by the European Parliament’s Committee on Economic and Monetary Affairs (ECON) to allow central counterparties to accept gold as collateral has been a great step while considering the gold market news. This is yet another act of recognition of gold’s growing relevance as a high quality liquid asset. Market demand for gold to be used as a high quality liquid asset and as collateral has been building for some time. In late 2010, ICE Clear Europe, a leading European derivatives clearing house, became the first clearing house in Europe to accept gold as collateral. In February 2011, JP Morgan became the first bank to accept gold bullion as collateral via its tri-party collateral management arm. Exchanges across the world, such as Chicago Mercantile Exchange, are now accepting gold as collateral for certain trades and London-based clearing house LCH Clearnet has said that it also plans to start accepting gold as collateral later this year.

We suppose that Europeans have noticed that Greece has 111.5 tons of gold, Portugal has 382.5 tons, Spain has 281.6 tons and Italy is top dog with 2,451.8 tons. That’s a lot of collateral.

The euro zone problems keep impacting the price of gold positively. It seems that if Greece thought all its troubles were over with the coming of the Apocalypse, it seems that for now it will have to deal with its problems after all. Greece doesn’t have any good options. Financial markets are jittery at the prospect of a Greek default since European banks are highly leveraged. They are not in a strong position to withstand losses on their large portfolios of European government securities if, as seems likely, Greek problems cause a fall in the market price of Spanish, Italian, Belgian, or other euro zone sovereign debt. The PIIGS were able to borrow so much relative to the size of their economies because creditors believed their debt was safe. A restructuring of Greek debt will cause big losses to French, German and other banks, not to mention the havoc caused to the entire euro zone and, in turn, to the global economy.

To see if we should be in rapture over the prices of precious metals, let’s turn technical part with the analysis of the Euro Index (charts courtesy by http://stockcharts.com.)

In the long-term Euro Index chart, we see a number of profound implications which will impact precious metals move in the short-term. The index levels moved below late 2010 highs if you decide on measuring highs in terms of intra-day highs or even daily closing prices. The strongest support, though, is provided by weekly closing prices, taking this approach provides us with a bullish view on the situation as the euro did not break its previous high. The support line (thick line) is more important in the case of bigger moves than are the lines based on intra-day highs and lows (thin, dashed line).

In our previous essay (Gold, Euro and True Seasonals for Mining Stock) we wrote the following about the key support line:

We’ve based this support line on weekly closing prices (the most important implications are based on these prices) - 159.35 / July 7^th and 149.62 / Nov 23^rd.

Although the above chart doesn’'t allow for much precision because of its long-term nature, taking a closer look at the key support level that is currently in play provides us with a strong support right at the 140 level. This is where euro bottomed on Monday and reversed on Tuesday. This is a bullish development.

So with the euro apparently bouncing off the support line, let’s continue with analysis of the USD Index to see if the same can be seen (as expected) with respect to a resistance line.

In the long-term USD Index chart, the upper border of the declining trend channel based on – again - weekly closing prices has been reached. This is the heavy dark line in our chart and is providing resistance at this time. This is, of course, not surprising in view of what we saw in our prior chart of the Euro Index.

What this means is that the dollar is likely to move lower once again. This is good news for precious metals as gold, silver, and gold and silver mining stocks are all likely to move higher in the event of a downturn in the dollar.

In the short-term USD Index chart, if daily closing prices are used, then the breakout has not been confirmed at this point. However, if we choose to base last year’s November low on intra-day lows, the breakout appears to be in. Due to this confusion, we feel it best to state that it does not appear that the breakout has been confirmed. This is especially true when taking the long-term chart into consideration.

The next cyclical turning point for the USD Index is expected in early June. This means that the current trend could very well reverse in a week or so, but it could mean that a decline will be seen in the following days and a rally will materialize soon after that.

Naturally, that would imply that the coming decline in the dollar would be short-lived – so the question is if it could be really meaningful and worth taking into account at all. We believe that the answer is yes – please note that half of the dollar’s May rally materialized in just two trading days. It is important to keep in mind that the same could happen to the downside in a similar rapid move.

Summing up, the short-term situation remains bearish for the USD Index and bullish for the Euro Index, which makes the short-term picture for the precious metals bullish as well.

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Thank you for reading. Have a great weekend and profitable week!

P. Radomski

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This week the correlations between precious metals and other assets have turned upside down. We have examined this phenomenon closely and it turned out that it does provide us with additional insight at today's market juncture. In fact, this was one of the reasons based on which we adjusted our upside targets for the current rally.

The situation in the general stock market appears bearish at the first sight, however taking a broader perspective allows us to see what is really going on with stocks (and most important - what's not). Moreover, in today's Premium Update we take two different views on the financial sector and explain which of them should be viewed as short-term timing signal and which is just a long-term tendency indicator.

Finally, today's Premium Update includes the True Seasonal chart for gold that takes gold options' expiration into account. We use this chart to estimate the probable timing of the next turning point in metals and it confirms points made in other parts of the analysis thus further increasing their reliability.

We encourage you to Subscribe to the Premium Service today and read the full version of this week's analysis right away.