Dollar sell-off key to rally in commodities

The dollar hit a resistance level on Monday, increasing the probability of a sell-off that can lead to a rally in commodity markets.

Over the past few days, the dollar rallied, leading to a correction in several commodities. Commodities generally move in the opposite direction of the greenback. In fact, over the past several months, the devaluation of the dollar by the US Federal Reserve has lead to a rally in commodity markets.

Since late November, the dollar index has been stuck in 78.75-81.50. The dollar index, listed on the New York Board of Trade (NYBOT), measures the greenback against six major currencies. On Monday, the index hit the upper limit of the range and began to sell off. This resulted in a pause of the sell-off in commodities and a small rally. A continued sell-off in the dollar can lead to a rally in commodities.

Commodity traders and investors must keep a close-eye on the dollar index given the inverse relationship between the two. If the dollar index breaks out of 81.50, it will be a bad news for commodities. A break-out can result in the index going all the way up to the 82.77-83 level. At the time of writing this article, the dollar index has an easier path down than up. However, keep in mind that many commodities such as crude oil and copper are near key resistance levels.

Gold versus dollar
Gold over the past several months was relatively stronger than the dollar. This is so, as gold has been making new highs as the dollar traded in a range. If the dollar and gold were equally strong, both should have traded in a range. Relative strength in gold means that a fall in the dollar will result in a stronger rally in gold.

However, it’s wise to sound a note of caution. Any asset in an uptrend makes higher highs and higher lows. What this means is, whenever the price of the asset rallies, it breaks to new highs, but when it corrects it does not make a new low. When the uptrend is over, the asset begins to make lower lows and lower highs.

For the first time in several months, gold futures contract made a lower high on January 3 and a lower low on January 7. Technically, one might not call it a lower low yet, as prices did not close below the previous low of $1,361.70 and rallied to close higher. So, while it’s OK to be bullish on gold with the dollar at resistance, one should remember that the markets have given us the first sign of possible weakness. Also, keep in mind that during the recent rally, the dollar index rose 3 per cent, but gold fell 5 per cent.

Silver versus dollar
In our previous articles, we had mentioned that silver is likely to correct strongly as it had rallied strongly. In the latest sell-off silver fell 9.5 per cent, while the dollar rallied only 3 per cent. This indicates that silver is relatively weaker than the dollar in the short term. However, with the dollar selling-off, there has been slight rally in silver, which can continue if the greenback continues to fall.

Crude oil versus dollar
Sweet crude oil fell 6 per cent as the dollar rallied three per cent. We believe the steady up trend in crude will continue till it hits key resistance levels, which are at the $94 and $96 per barrel level.

Copper versus dollar
The copper futures contract had a false break-out of its all time high of $4.42 recently and sold off. Copper futures are traded on the COMEX, under the ticker symbol HG in US cents per pound. In the recent rally of the dollar index, copper sold-off by 5.5 per cent, but is still to rally. Hence, it’s possible that copper may sell off some more.

The author is based in Chicago and is the editor of www.capturetrends.com