Reversals – Check. Declines – Check. Being Prepared – Double Check.

Gold declined profoundly this week, but the key action is still behind the scenes – in the USD Index.

Let’s start today’s analysis with an overview of the situation in the forex market because the implications are so profound.

Reversals – Check. Declines – Check. Being Prepared – Double Check. - Image 1

Two weeks ago, when the USD Index moved below 99.5, I wrote the following:

“As you have definitely noticed, the USD Index plunged this week. It even moved to new yearly lows!

The most important takeaway from this event doesn’t come from the USD Index itself, though. It comes from gold, which is nowhere close to its recent highs. In fact, it’s more or less where it was in mid-May. In other words, while there is some immediate strength in gold, it’s all part of one big weakness relative to what’s happening in the USD Index.

This means that when the USD Index finally does show strength, gold is very likely to respond with powerful declines.

And the thing is that the USD Index IS likely to reverse and soar very soon.

Slightly lower than expected CPI and lower than expected nonfarm payrolls didn’t justify a decline this big. The market simply wanted to decline as it seems that the market participants are still in denial and expect the Fed to start cutting interest rates shortly once again. And it can’t without limiting the demand. The move lower in the USD Index just made this task harder for the Fed as the U.S.-produced good just got much cheaper for foreign buyers.

On a technical front, each move below 101 (and 100 is even more profound support as it’s an extremely round number) was quickly reversed and followed by a rally. And since we now also see a strong buy signal from the RSI (we haven’t seen it this low in well over a year!), it’s very likely that we’re seeing a bottom in the making right now.”

Indeed, the USD Index is right after a profound reversal and a comeback above the all-important 100 level. It’s also after a decisive comeback above the previous yearly lows.

The above can be understood as the chart saying: “No way! The USD Index is NOT going lower now!”

And yes, gold is responding accordingly – by moving lower.

Those levels are critical as round numbers tend to be very important technically (=psychologically). Breakdowns and breakdowns are important, but their invalidations are even more important. The latter proves that the market was “forced” to move in a given direction, but that it doesn’t really want to go there / in that direction. USD’s rally is a perfect example.

Reversals – Check. Declines – Check. Being Prepared – Double Check. - Image 2

The fact that the reversal came after RSI moved to its yearly lows and the level from which it then moved higher for weeks (and the same happened in the USD Index itself) makes the outlook even more bullish.

Additionally, let’s keep in mind that it was about time for the USD Index to reverse.

Reversals – Check. Declines – Check. Being Prepared – Double Check. - Image 3

The USD Index tends to form major bottoms close to the middle of the year, and that’s where we are right now.

The 2008, 2011, and 2014 bottoms formed in the middle of those years.

The situation in the biggest component of the USD Index: the EUR/USD exchange rate, confirms the above outlook.

Reversals – Check. Declines – Check. Being Prepared – Double Check. - Image 4

The RSI based on the Euro Index was just practically right at the 70 level, thus flashing a sell signal. These signals were very reliable in the past, especially when the Index was right after a short-term breakout.

Those breakouts were then invalidated, and bigger declines followed.

The latest breakout was just invalidated as the EUR/USD moved back below 1.1

It’s bearish on its own as it’s a sign of weakness, but what really stands out is that those comebacks and (failed!) attempts to move to new highs are typical for the European currency. Tiny fakeouts were what preceded declines – massive ones – many times in the past. Even the situation in the RSI indicator (upper part of the above chart) points to the situation right now being similar to what happened previously.

And as the euro declines, the USD Index rises. And gold declines as well. The same with copper.

As gold declines, mining stocks are very likely to decline more (as they’ve done in the previous months and years).

This creates one of the greatest trading opportunities of the year – and when taking a medium-term focus – of the decade.

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Przemyslaw K. Radomski, CFA
Founder, Editor-in-chief