US Dollar Index At 35 Year Support Level; Gold is Your Best Friend Now

``Nixon Administration officials were convinced that cutting the dollar's tie to gold and devaluing it against other currencies would increase our exports, slash imports and give us a fabulous round of prosperity. Instead, unhinging the dollar from gold gave us more than a decade of debilitating inflation, catastrophic increases in the price of oil and record-high interest rates.”-Steve Forbes

Going back to the US dollar Index, we noted last week that as the US dollar plumbs to its critical juncture, gold and the precious metal group are likely to benefit from the erosion of the US dollar’s value.

Figure 3 Chartrus.com: 35 year price action of the US dollar Index

In the past 35 years, figure 3 courtesy of sharelynx.com and chartrus.com, the 80 levels of the US dollar index (shown by the red horizontal arrow) has been the bailiwick of the US dollar bulls where thrice (1992, 1994, 2005) they were successfully able to repel the US dollar bears. Obviously this will be the fourth attempt.

Last Friday, with the US dollar at 80.12, we apparently stand at the crossroads.

With that in mind several questions pop up…. Will the bears muster enough force to BREACH for the FIRST time the ALL important 35 year threshold level? If the support gives, will the decline be orderly? Will the assault on the 35 year support levels be violent or are we going to see a nasty bounce off from the 35 year support levels? Will the global FIAT money based system face tension for the first time since the gold window was closed in August 15, 1971? Or could there be a US dollar crisis?

Most of the signals APPEAR to point towards a successful breakdown of the US dollar index, such as the continuing saga of US subprime, structured finance and housing jitters, rising interest rates across the globe, outperformance of Global economy relative to the US, and rampaging commodity prices.

Meanwhile in the context of Gold, which closed on Friday at the TOP of the resistance channel in figure 1, a successful upside breakout next week, could lead it to a test on its previous May 2006 high at $720, and potentially, lay siege on its all time high at $850 back in 1980 anytime soon. Perhaps, by first quarter 2008?

Echoing the activities of Gold is the world mining indices. Lately, when gold prices attempted to move higher, global mining indices stagnated or simply did not follow gold’s price actions. Some analysts pointed to rising operating costs, which depressed profits, as the main reason for its deviation.

However, as of Friday, almost in synchronicity, we see global mining indices surge such as the AMEX Gold bugs, FTSE AustralAsia, FTSE Africa, FTSE Gold Americas, Japan’s TSE Mining index and Canada’s S&P/TSX capped Gold Index.

We are unsure if the Philippines counterparts will follow suit. Given the historical perspective, their correlation with global mines appears to be low. However a knock on effect from the floundering US dollar and the recovering gold will likely continue to influence global mines. And with that being the case, given the growing exposure of Philippine mining industry to the international arena, the probability could be tilted towards a spillover from the international field to the local mining index.

Simply said, if the global mining indices will continue to validate the movements of the prices of the precious metals then one can expect foreign money to pour on into the local mines very soon.

In the absence of a domestic commodities market, then the best recommended alternative would be an adequate exposure to the mining industry as insurance to the possibility of a vehement reaction to the US dollar’s breakdown. Remember gold stands not as your ordinary commodity but your alternative currency.

Well, for as long as the market’s response is orderly this should actually not be limited to the mines.

We must also not forget that the Philippine stockmarket cycle has been moored to the fate of the US dollar. Since the Phisix’s cyclical troughs in 2002, a declining US dollar has greatly boosted foreign portfolio flows into the country, from which so far has driven our Phisix to record territories. And our Phisix has largely played out closely alongside with the activities of its emerging market peers, responsive to the actuations of the US dollar.

Our bullish premise is conditional to the orderly and smooth decline of the US dollar index plus an equally upbeat or low volatility in the US equity market, as similarly reflected in our peers or the emerging market class and in our neighbors, the Asian markets.