Dollar broke down, gold's breakout imminent.

by John Lee

07/18/2007

In June I wrote:

The dollar is likely to meander between 81 and 200 DMA of 84 for another month. Hiking of euro rates failed to propel Euro past 1.35. I still think USDX will break out to the upside.

I have been bearish of the Euro at 1.35, I still don't think Euro can take out 1.35. Euro at 163 to the yen is just not natural in my view.

I was wrong, plain and simple. The dollar is showing exceptional weakness and another 5-10% breakdown can not be ruled out.

The Euro, a junk currency, has now broken through key resistance of 1.37, if 1.37 holds, this week, we can see the dollar index below 80. I believe people are betting against the dollar due to the inability for the Fed to raise rates (subprime problem) to calm inflation and make the dollar more attractive.

The (relatively) free-trading Asian currencies such as Philippine Peso and Thai Baht also have gone up 10%+ over the dollar this year.

I see another 10-20% upside in those currencies in the next 12-24 months, and as much as 40% upside for RMB (i.e. 5 RMB to 1 USD) in the next 5 years.

You think I am crazy? 5 years ago Canadian dollar was C$1.45 to US $1. Now it's C$1.04 to US $1.

The Canadian dollar rallied over 13% since March. This is nothing short of a crash by the dollar over the loonie.

I don't see any impending crisis by the dollar's breakdown, it will just bolster the case for gold, the sore lager in catching up to dollar's fall.

Gold and Silver:

In the June update I wrote:

Gold is clinging on to $650, which acts as solid support. Gold has never dipped below 200 DMA ($635) for more than a month at a time and I don't think it will go that low with May already behind us.

While I was wrong on the Euro, I was right on gold. With most major and Asian currencies having broken out against the dollar, I place very high probability of gold breaking out of $670 and then $700 by September.

In June I wrote:

XAU is still in consolidation mode. However the XAU:Gold ratio is ticking up and challenging 200 DMA. Gold equity continues to go up against gold this could signal the final bottom for both gold and gold equity.

If XAU survives and stays above 150 this week, we should see it challenge its 2006 high of 170 before September. XAU:Gold ratio also broke out. This indicates a bottom for both gold and XAU. If the ratio restores to its old high of 0.28, a $700 gold would mean a XAU of 200. A $850 gold price coupled with XAU:Gold ratio of 0.28 would mean a XAU of 240. XAU would be my first profit taking level and my target for 2007.

Equity Markets:

In June I wrote:

S&P is now in overdrive. The Dow just made all time high. Many American readers are confused. I have talked about this before. The Dow is made up of 30 stocks such as 3M, AIG, GE, Merk, Boeing. http://quote.yahoo.com/q/cp?s=%5EDJI Those stocks reflect the global economy, not American economy. There are huge virgin markets that those companies are being exposed to for the first time. India and China combined have 7 times more people than US. The stocks are priced in USD therefore are on sale to the Asians and Europeans. Coupled with private equity buyout frenzy to boost interest and plunge protection team to guard downside we have a recipe for a bull. If you want to get bearish, wait till S&P500 goes below 1,300. Otherwise go out and have a nice summer.

Equity market still in overdrive across the globe. A breakdown by the dollar would only mean further upside for equities

CRB and Oil:

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Oil looks to test $80. I am very surprised at its strength, which is a partial reflection of the dollar's weakness. I wouldn't rule out a break out over $80 if the dollar breaks beneath 80.

Conclusion:

The dollar is now showing exceptional weakness and now sits on critical support of 80. The breakout of Euro caught us somewhat by surprise. Lingering subprime issue prevents the Fed from raising interest rates, and persistent trade deficit and deteriorating global image of the dollar means dollar could have further downside to go. This is bullish for gold. There was no crash by the XAU so far this summer as we rightly predicted. The XAU:Gold ratio clearly broke out to the upside, which means gold and XAU have both likely bottomed. XAU is now favored over gold from risk / reward perspective. We see July and August as last chance to buy XAU before its spectacular break out above 200 this year.