Breakout by Oil and Commodity index signals a bullish trend for gold.

by John Lee

04/24/2006

Dollar and Bonds:

Dollar and Bonds:

From the April 15th Update

“The dollar index seemed to have broken down from the head and shoulder pattern. We expect the euro to break out of usd 1.23/euro shortly. Inflation may be a well known fact among gold bugs, but it takes a breakdown by the long bonds to convince the investment community that inflation and high commodity prices are here to stay.”

Last week euro broke of $1.23 level and the dollar lost heavily against the yen. Russian Finance Minister Alexei Kudrin stated that "The U.S dollar has not been very stable in the past years" and that the dollar isn't the "absolute reserve currency" and that the "U.S. swelling deficit could affect the dollars stability eventually."
The central bank of Sweden, the Riksbank announced that it cut holdings of dollar-denominated assets by 50% and added to its holdings of the euro and the Norwegian krone. While we see Sweden's reserve of $20 billion as non-material in scale, the trend of central bank reserve diversification away from US dollars is set and likely to continue.

Finally, minutes from the Fed's latest monetary policy meeting have suggested that the pattern of tightening U.S interest rates may be ending soon. The news could be bearish for the dollar, as the incremental rate hikes that began June 2004 have provided the dollar with an attractive rate differential vs. the euro and yen, and helped fuel the dollar's rally in 2005.

The Euro currently stands at $1.23 and is set to climb even higher. We see the euro possibly challenging it's old high of 1.35 by the end of the year.

Gold and Silver:

This is from the April 3rd update
“Gold has produced further gains in the last 2 weeks and is set to breach $600/oz shortly. Our target continues to be $650 before the summer ends. Silver has been relentless and is at a level not seen since 1984. While we don't recommend instituting new position in silver/silver equities, we are not about to lighten our silver positions yet either.”

Our $650/oz target was almost met last week. On Thursday April 20th Gold ($645.75/oz) and Silver ($14.68/oz) reached new quarter century highs during Asian and European trading.

Newmont's president Pierre Lassonde on Thursday he announced that he anticipates "an exponential increase in the gold price" and that the $850/oz gold price of the 1980s could be challenged during the next 18 months. In the short term, Gold could re-test support of $580 - $600 before eventually breaking out of $650 range by the end of the year.

XAU

From the April 15th Update:
“XAU over gold ratio indicates that gold equity market is not yet overheated. The past peak of XAU/gold ratio is around .28. This means at a $650/oz gold price, we would start profit taking at XAU of 180 . Right now we see current XAU level as a great entry point.”

The XAU reached a new high of 160 last week. It might take a few tries before XAU decisively breaks out of the 150-160 level. Again we don't see a premium in gold stocks yet, relative to the current price of gold.

CRB and Oil

From the April 15th Update

“CRB uptrend is intact. Oil is again challenging the $70/barrel level for the 3rd time. 3rd time is the charm and we expect oil to breakout of $70 to test $90 this year.”

The CRB broke out of 350 resistance level and looks to advance further. The breakout by oil signals the start of a new commodity uptrend. Oil however might retest the $70 support before eventually peak at $80-$100 this year.

S&P500, Nikkei, Shanghai

From the April 15th Update:

“As expected, Shanghai stock market steamed ahead. US and Japan equity markets experienced modest correction from inflation worries. We look for Shanghai to further play catch up.”

The Shanghai stock market has made healthy gains throughout this week. Although more volatile, the Nikkei also advanced. The S&P 500 seems to be forming a rising wedge which is technically bearish.

Conclusion:

As we mentioned in the April 15th update, the breakdown by long bonds signals an inflationary era. We believe last Thursday's correction in gold and silver was a short term, isolated event possibly due to cleverly-engineered short-covering. Dollar stayed below the breakdown level while euro, CRB, Oil, and Newmont stayed above the breakout level.

If we are right about the analysis above, then the correction in gold and silver should end by the end of April. The last time when Newmont broke out of multi-year resistance of $28 in June 2003, it went to $50 in 6 months. This time the $50 multi-year resistance was overcome in December 05 and we think a reasonable target in the next 12 months for Newmont is $100.