Weak Dollars and Strong Commodities?

Many market analysts believe there is an inverse relationship between the value of the United States dollar and the price of commodities. It isn’t uncommon to see headlines like these:

“U.S. Dollar’s Weakness Boosts Commodity Prices”

“Weaker Dollar Boosts Oil, Gold & Silver”

Some analysts claim this relationship is so powerful it outweighs the effect of fundamental factors. Others say the relationship is secondary to fundamentals like supply and demand. Some say the relationship is causal. Others say it is psychological, affecting the perception of traders. With so many opinions, whom do you believe?

As a technical trader, I always prefer to go to my charts and see what they tell me. I’m not so much interested in why such a relationship may exist. I’m interested first to see for myself whether such a relationship does in fact exist. Then I can decide how to use this knowledge to improve my trading success.

So let’s begin by looking at two charts that provide the easiest way to decide whether or not there really is a relationship between the value of the U.S. dollar and commodity prices. First we’ll look at the daily chart for the U.S. Dollar Index. We’ll look at a weekly chart, which gives us a more long-term picture than the daily chart.

Now let’s compare that with the chart of the CRB Continuous Commodity Index cash market, which is composed of data from a group of commodities that are believed to be the first to react to changing economic conditions.

When you look at these two charts together, the inverse relationship is quite noticeable.

In early to mid-2007, both charts are trading in their mid-range. From there, the U.S. dollar drops to a series of lows, while the CRB rises to highs. From mid-2008 the CRB steeply plunges from its high, reaching its low in the third quarter of that year. During that same time period the U.S. dollar soars to new highs. It then dips and hits a second high in early 2009. It then starts a steady downtrend until it hits a new low toward the end of 2009. By contrast, from 2009 to 2010 the CRB moves steadily upward. Then comes 2010. The U.S. dollar shoots up to a new high in mid-year, and then falls. Again, in contrast, during 2010 the CRB drops to a minor low (corresponding in time to the U.S. dollar high) and then soars to new highs. The two charts are almost mirror images of one another.

Now let’s look at the charts of some specific commodities to see whether they show the same pattern. Let’s start with the weekly chart for gold.

Although the range of the highs and lows varies between gold and the CRB, the shapes of the charts are very similar, with highs and lows being made within the same time frame.

Now let’s look at the weekly chart for corn, an example from the grain sector.

The corn chart is very similar to the CRB chart, with highs in mid-2008 and lows in the third quarter of 2008. Whereas the CRB chart then entered a steady climb, the corn chart remained in a trading range before starting its climb in 2010. The charts look very similar from mid-2010 to the present.

The story is the same for a number of other commodity markets. If you’re interested, you might check out the charts for crude oil, coffee and sugar, for example.

Now let’s look at some daily charts to get a closer-in look. Look at the chart of the March 2011 U.S. Dollar Index.

We see that over the four months from September through December, prices dropped to a low in early November; then they rose to a high in late November; and then entered into a mid-level trading range.

Let’s compare that to the same time period in the CRB CCI Index cash market.

In early September, while the U.S. Dollar Index was high and then began to drop, the CRB Index started low and began to rise. It hit a high in early November that corresponds to the low in early November made by the U.S. dollar. CRB prices then dropped to secondary lows in mid to late November, at the time that the U.S. dollar was heading for a high. After that CRB prices rose steadily, while the U.S. dollar Index entered a mid-level trading range.

Judging by these daily charts, it looks like the inverse relationship between commodity prices (as represented by the CRB Index) and the U.S. dollar seems to be holding for the short-term, as well as the long-term.

What does this mean to traders? Well, we can’t say for sure what causes this relationship, but we can see that it exists. If the U.S. dollar is making a big move, there’s a good possibility the commodity markets will be moving in the opposite direction. So, when we see the U.S. dollar moving, that can be our signal to check the commodity markets and consider trading them in the opposite direction from the dollar. This assumes an examination of the charts reveals that all the correct signs are there. And, of course, always take the right steps to manage and protect your position.

– Jim Prince

To Profit From The Gold Market, Timing Is Everything

The gold market has gotten a lot of attention lately. Through the end of June, prices were soaring, and many people—professional traders and savvy amateurs alike—made nice profits trading gold on the commodity exchanges.

Since then, prices have backed off a bit. So now the big question traders are asking themselves is, “Should I look to get into the gold market now, or is it too late?”

When it comes to trading gold, or any other commodity, timing is everything. Technical traders time their trades using signals on charts of previous price activity in a market. They look for the appearance of standard formations that indicate the time is right for a market entry or exit. If the signal isn’t there they’ll sit on the sidelines until their charts give them the green light.

What are the signals in the gold market telling us? First, look at the weekly chart (a relatively long-term chart) of gold so you can see what all the excitement is about.

Dec 2010 Gold
Weekly Gold through July 16, 2010 (view full-size image)

You can see how high prices are compared to where they’ve been. In fact, those highs at the end of June are the highest this commodity has ever been.

Now look at a recent daily gold chart to see what it tells us. It’s a chart of prices for December 2010 Gold (gold contracts that are due for delivery in December, 2010).

Dec 2010 Gold
December 2010 Gold from Oct. 2009 through July 21, 2010 (view full-size image)

You can see the highs that occurred around a price of $1,270 per ounce, and that prices are now hovering around $1,180. So, what are traders to do now?

In my opinion, while the gold market may still be offering a tremendous opportunity in the long term, this is not the time to be getting in. This is the time to be waiting on the sidelines, and there are a number of reasons why I say this.

First, one of the primary principles of the trading methodology I follow is to trade with the trend. That means if the overall trend in a market shows that prices are rising, we want to buy the market—known as going long. Conversely, if the overall trend in a market is down we will sell the market—also known as going short.

We don’t want to go against a market. If the overall trend is up, but the market appears to be making a correction with declining prices, we don’t want to sell that market. We will wait to see if prices resume the rise and then we’ll buy. On the other hand, if the market clearly shows that the trend has reversed and that prices will continue to fall, we may then consider selling.

For all we can tell right now gold is only making a correction, which is to be expected in a market that has just made all-time highs. No market goes straight up or down. There are always advances, and then pullbacks, all along the way. As far as we can tell right now gold is in such a pullback and there is no indication at this point that the trend has reversed. But we don’t want to buy into the market while prices are declining because we have no idea how low they will go. As technical traders we would only consider buying when prices have clearly resumed the uptrend.

How low could prices go in a pullback? Look back on the December Gold chart and look at the horizontal line I drew. This is the 50 percent line. I determined where to draw this line by adding the high and low prices of the last major move in Gold and dividing the result by two.

There’s tremendous psychological power to the 50 percent line. Prices seem to be drawn to it like a magnet. Traders watch as prices approach this line. Often declining prices will bounce off this line and head back up. That may happen in gold. The 50 percent level is at $1,105. With current prices at around $1,180, that means gold may be being pulled all the way toward $1,105. That’s a pretty scary drop and there’s no use trying to catch a falling knife. I’d rather wait for prices to resume the rally before getting in.

Finally, there’s a fundamental reason why this may not be the best time to buy gold. As a general rule, gold prices tend to peak in late summer, and then decline through October when they usually bottom out. Then they tend to rise through the end of the year. If that pattern holds true this year, don’t be surprised if gold prices hold steady or decline until November. After that, if they resume their uptrend we may see new record highs.

So, how will we know when it’s time to consider entering the gold market? If you look at your gold chart it will tell you. What you want to look for is the leveling off of the downtrend followed by a resumption of the uptrend. This will likely occur when the traditional seasonal rally kicks in toward the end of the year. However, there are never any guarantees in trading. That’s why we have to look to our charts to confirm the wisdom of our trading decisions.

Successful traders only buy into a market that looks like it wants to move higher. If you’re interested in trading gold, become familiar with the chart patterns in this market and learn the signals that indicate the timing is right.

—Jim Prince