Based on the September 9th 2011 Premium Update. Visit our archives for more gold & silver articles.

Conventional wisdom has it that there are three safe haven currencies—the Swiss Franc, the Japanese Yen and the U.S. dollar. But perceptions are changing. The US dollar is no longer the default shelter for long-term investors. Instead, the Swiss franc and the Japanese yen have been the hideaways in a financial storm along with history’s longest used currency—gold. But both the Swiss and Japanese governments are desperately trying to curtail their currencies appreciation and to curb the inflow of investments by selling their currencies into the market and creating an oversupply which will lower prices. They have both cut interest rates to zero. A strong currency makes it difficult to export your country’s goods.

It’s easy to understand why investors have perceived the Swiss franc as a safe haven. Switzerland boasts a strong economy which is not plagued by high national debt and budget deficits. With its conservative Swiss banking monetary policy, it has not resorted to money printing schemes with names like “quantitative easing.” The Swiss franc reached milestone parity with the dollar in 2011 and since then has appreciated by an additional 20%. The franc is up 5.41% against the euro this year and almost 14% against the dollar.

However, last Tuesday, the Swiss franc plunged dramatically versus the euro and other major rivals after the Swiss National Bank took the extraordinary step of setting a floor for the euro/Swiss franc exchange rate at 1.20 francs and vowed to buy “unlimited quantities” of euros to defend it.

Needless to say, this gave gold a boost. It reached a record of $1,923.70 an ounce in trading Tuesday of contracts for December delivery, before retreating below $1,900. The price of oil has fallen because of the global slowdown, eliminating another place where investors might be tempted to stash cash. The SNB's move was widely viewed as positive for gold because the metal will gain even more popularity as a safe-haven investment of choice.

For the past 14 months the franc has experienced a parabolic rise as financial instability beset many of its neighbors as well as the US. The move by the SNB puts the central bank in direct conflict with a strong desire by market participants to buy safe-haven assets. Since there is a good chance that the eurozone crisis will only get worse, the Swiss intervention could prove to be very costly to the SNB. The move underscores the particular challenges facing Switzerland at a time of global economic uncertainty.

This is not the first time the Swiss central bank has resorted to such a strategy to contain the franc. It used a similar strategy in the late 1970s to weaken the currency against the Deutschmark. The central bank’s new target commits it to buying euros and selling francs any time the euro falls below 1.20 francs. That amounts to setting a floor for the euro or a ceiling for the franc.

What is true in the long-term does not necessarily have to be valid in the short-term. Even though the long-term outlook for the dollar is rather cloudy, investors have been buying large amounts of dollars in the last few days. It seems that the fact that German officials reluctantly start to admit that a Greek default may be the only way to resolve the current crisis of the euro has coerced investors into buying the greenback rather than gold and the Swiss franc.

Why is that? One way to explain this is to point to the recent depreciation of the franc against the dollar. The aforementioned peg of the franc to the euro has affected the USD/CHF exchange rate as well. This means that, at least in the short term, the franc is less attractive that it was a couple of weeks ago. If you couple that with the recent parabolic rally in gold and the fact that investors and traders start to doubt whether gold is poised to continue its move up in the short-term, you may come to the conclusion that in the short-term the dollar has recently become more attractive. This is why we currently see a considerable movement of capital from the eurozone to the USA.

All of the factors mentioned above have added to the recent move up in the USD Index. To see how this may influence the precious metals sector, let’s move on to the technical part of today’s essay. We will begin with the long-term Euro Index chart (charts courtesy by http://stockcharts.com).

The index moved sharply lower this week, and it is now below the declining resistance line marked with red on the above chart, which opened the door to significant declines towards the 135 level. If the downward move continues, the index may move to the level of 130 or even lower. This week’s developments will likely have further positive implications for the dollar.

In the short-term USD Index chart, we saw the index break above the declining resistance line last week. This short-term move in fact created a breakout from the long-term perspective as well.

This has become a bullish signal since this move ignited a move above the long-term resistance line which in turn will likely ignite a rally from a long-term perspective. The hitherto rally has brought the USD Index levels up to as high as 77-78 and the move is likely to continue to the level of 80 or even higher. All this will likely have negative implications for the precious metals sector.

Please, recall what we wrote on September 7^th in our essay on gold and the Swiss franc:

(…) the recent appreciation in the euro seems to be short-lived and we currently do not view it as a bullish signal for precious metals. The following rally in the USD Index took the dollar above the declining trend channel, which – if confirmed and no additional factors emerge – will likely correspond to a decline in the precious metals.

This is precisely what followed – the euro retraced and declined further, the dollar rallied and the PMs moved lower. Combine that with the fact that the move in the USD Index was significant and that it appears to be an early part of a bigger move up. This is where medium- and long-term correlations come into play and these are negative for the dollar and the precious metals sector. Consequently, the precious metals sector is likely to move lower based on dollar’s rally.

Summing up, the situation in the USD Index is bullish this week and quite the opposite is true for the Euro Index. The latter declined sharply this greatly contributed to the positive moves of the dollar. The short-term implications for precious metals are bearish.

The influence of these currencies is likely to be very visible throughout the precious metals sector. It appears that the key signal to watch for this week is whether the USD Index can retain its upside potential. This would greatly increase the probability of lower precious metals’ prices in the weeks ahead. While this is pertinent to the short-term, the long-term outlook (following years) for precious metals has not changed and remains bullish. We advanced arguments in favor of such a point of view in our recent essay about the comparison between two gold bull markets.

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

P. Radomski

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