Thursday, September 20, 2007

The Reasons Behind Gold's Strength

Today, gold exploded past its old May 2006 high without the slightest bit of hesitation. I was anticipating at least a brief respite at this level, but gold's powerful momentum proved otherwise. You may be wondering why gold has been doing so well lately. I will try to explain why in this post.

I believe that much of the yellow metal's strength is being derived from a weak US Dollar. On a fundamental level, this has to do with the fact that the Fed was forced to lower rates. But since this site deals with the technicals, let's have a look at the US Dollar Index's daily chart:

The main point in the above chart is that the US Dollar has broken the psychologically important 80 level. As you can see, the currency has really fallen apart since the 80 level was breached. I have tried to illustrate the implications of this event in several articles written on this blog. For example, on July 25, 2007, I said:

"However, it's only a matter of time until this level [80] is broken, and once it is broken, things could get really nasty for the USD. The USD is in a massive downtrend, and, in the long run, it never pays to buck the trend. This fact, that the USD is in such bad shape, will be one of the fundamentals that will drive gold higher..."

Let's have a longer term look at the USD Index so that the gravity of the situation can be better understood. The following chart is a monthly chart, and goes all the way back to 1985:

For a larger view, please click on the image above.

As shown, the US Dollar index is currently trading at the lowest level of the index's existence. (In case you're wondering this index measures the US Dollar against a trade weighted basket of six other currencies, primarily the Euro, but also the Canadian Dollar, the Yen, the British Pound, the Swiss Franc, and the Swedish Krona. )

But back to the point, the fact that the US Dollar index could not hold 80 clearly shows that the currency has very little strength, and is something that is very bullish for gold in the long-term. I feel that this event is one the main factors that is driving gold's strength right now.

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