USDX: A Crocodile Just About To Strike

Written by: Przemyslaw Radomski, CFA

Taking a sip from a crocodile pond is risky, but some animals try anyway. And die. Beware, as trying to profit from the PM’s pool now could end alike.

Just as ignoring a crocodile hiding in plain sight, ignoring the USD Index is a dangerous activity. And while investors continue to drink from the pond, the greenback’s nose is literally perched at the water’s surface. The USD Index is currently consolidating below the neckline of its inverse (bullish) head & shoulders pattern, so its wide eyes are also glaringly visible. And with a strike liable to happen at any moment, a leap above 93 could make the USD Index devour gold, silver and mining stocks.

To explain, the USD Index often soars during the summer months (major USDX rallies often start during the middle of the year), and while the greenback’s back-and-forth movement has uplifted the PMs, once the USDX resumes its likely uptrend, the former’s optimism could dissipate rather quickly. As a result, if the ambush ushers the USD Index above 93, the next stop is likely 98.

Please see below:

Furthermore, the seasonal thesis remains intact: I mentioned above that the USD Index often records material upswings during the middle of the year. And with the hunter’s disguise nearly always catching overzealous investors by surprise, will the next trap be any different?

In fact, the USD index seems to be breaking above the neck level of its inverse head-and-shoulders formation at the moment of writing these words.

The week started with a breakout, so there’s plenty of time for the markets to react before the next bigger break takes place (the next weekend). In other words, this week could be quite volatile and nothing like the previous weeks’ boredom. Gold, silver, and mining stocks might slide quite profoundly before we hear Friday’s closing bell.

If you analyze the chart below, you can see that summertime surges have been mainstays on the USD Index’s historical record and double bottoms often signal the end of major declines or ignite significant rallies. For example, in 2004, 2005, 2008, 2011, 2014 and 2018, a retest of the lows (or close to them) occurred before the USD Index began its upward flights. In addition, back in 2008, U.S. equities’ plight added even more wind to the USD Index’s sails. And if the general stock market suffers another profound decline (along with gold miners and silver), a sharp re-rating of the USDX is likely in the cards.

Please see below (quick reminder: you can click on the chart to enlarge it):

On top of that, the eye in the sky doesn’t lie. And with the USDX’s long-term breakout clearly visible, a profound uptrend is already in place.

Please see below:

As another important variable, the Euro Index’s recent symmetrical decline mirrors the drawdown that we witnessed in mid-2020. And if the Euro Index breaks below the neckline of its bearish head & shoulders pattern, the steep decline could usher the index back to the June 2020 lows or even lower. For context, the EUR/USD accounts for nearly 58% of the movement of the USD Index.

In addition, when the Euro Index reached the neckline of its bearish H&S pattern in early April 2021, late September 2020, and late October 2020, a fierce rally ensued. However, this time around, the corrective upswing has been extremely weak. As a result, with lower highs and lower lows plaguing the Euro Index in recent weeks, it’s likely only a matter of time before the neckline breaks.

Please see below:

Even more relevant, the completion of the masterpiece could have a profound impact on gold, silver and mining stocks. To explain, gold continues to underperform the euro. If you analyze the bottom half of the chart above, you can see that material upswings in the Euro Index have resulted in diminishing marginal returns for the yellow metal. Thus, the relative weakness is an ominous sign. That’s another point for the bearish price prediction for gold.

The bottom line?

Once the momentum unfolds, ~94.5 is likely the USD Index’s first stop, ~98 is likely the next stop, and the USDX will likely exceed 100 at some point over the medium or long term. Keep in mind though: we’re not bullish on the greenback because of the U.S.’ absolute outperformance. It’s because the region is fundamentally outperforming the Eurozone, and the relative performance is what really matters.

In conclusion, while gold, silver and mining stocks are increasingly treading water, the USD Index’s jaws are expanding. And with the greenback poised to take a bite out of the trio’s performance over the medium term, the precious metals could be in for a long and arduous recovery. However, after the drama unfolds, gold, silver and mining stocks are poised to continue their long-term secular uptrends.

Related: Inflation Nation: Pressure Builds, Underwater Beach Ball

The views and opinions expressed in this article are those of the contributor, and do not represent the views of IRIS Media Works and Advisorpedia. Readers should not consider statements made by the contributor as formal recommendations and should consult their financial advisor before making any investment decisions. To read our full disclosure, please click here.