Dollar, Crude Oil and Gold: Outlook and Trading Strategies

by Richard Ilczyszyn and Phil Streible

The U.S. dollar’s movements have affected a number of commodities. Gold and crude oil have seen a particularly strong inverse relationship with the dollar. The Federal Reserve’s next policy meeting is underway, and by the day’s end (Tuesday, March 18), we could see some dramatic moves in all these markets based on the Fed’s decision on interest rates.

U.S. Dollar Index

There’s no question the U.S. dollar has been in a deep bear market for some time. You can clearly see in the chart below (U.S. Dollar Index) how the beginning of the Federal Reserve’s easing cycle in 2007 affected the U.S. dollar—the more rates dropped, the further it plunged. ICE U.S. Dollar Index futures, which reflect the dollar against a basket of six different global currencies, have recently hit a new contract low as expectations priced in another big rate reduction at the conclusion of today’s Federal Open Market Committee Meeting.

When looking at any chart, I like to look at the key moving averages: the 5-, 8-, 15-, and 50- time periods. In the above Dollar Index futures chart, we are looking at these moving averages on a weekly time frame. These moving averages help identify where the market has been, determine key support and resistance points to trade, and where it might be headed next.

The Moving Average Convergence/Divergence (MACD) is at the bottom of the chart, and gives us more moving averages to consider, and a volume bar. A reading below zero indicates the dollar is still in a bear market and could continue lower.

I see more downside ahead in the U.S. dollar. It’s been one bad piece of economic news after another, and the bad news seems to be snowballing. I can see $69, $68 or even lower as a downside target for this market.

On the fundamental side the market has seen a drop in consumer confidence, weak manufacturing numbers and a really weak housing sector. All the most recent economic data serves up a good equation for a recession.

The Federal Reserve is expected to cut its key short-term lending rate, the Fed funds rate, by three-quarters or one percent. Anything less would be considered an unexpected result. As long as the Dollar Index futures remain below 72.87, the 5-day moving average, things look bearish. If you wanted to initiate a new position, I would consider selling rallies, and an as-expected Fed decision could bring a small relief rally in the dollar. I’d recommend scaling in, selling a contract around 72.87, one near 73.97, and one near 74.29, with your average price therefore around 73.50. I’d put a stop above the 50-day moving average at 75.25. Given the volatility in the markets lately, you might even need to widen your stops.

You can also consider purchasing a put option on a rally. I’d consider buying June puts, which have 80 days to expiration. The June 72 Dollar Index put would cost about $1,430, not including commissions, while the $71 put would cost about $1,000, not including commissions. Once there is about 60 days left to expiration, I would reassess the trade. If at that point, the trade is not going my way, I would start taking a much closer look at it. With 40 days left, if the trend has reversed, I’d exit the option as a money management approach, and move on to something else. When you break into the 30-day time frame to expiration, you face rapid time decay.

Crude Oil

While the dollar has been in the dumps, crude oil has been heading higher. Many traders have been using the crude oil market as a hedge against the declining dollar. If you look at the monthly crude oil futures chart below you’ll notice that I also look at the same moving averages we considered in the Dollar Index chart. I use these moving averages for markets that are trending. For markets that aren’t trending and are a little choppier, I would use Bollinger bands. You can also tighten up or expand the moving averages out to get a better idea of the direction of those types of markets.

Looking at the crude oil futures chart below, you can clearly see how high this market has shot up. Once it ran up into the mid $80 a barrel range, it seemed like $100 was a self-fulfilling prophesy.

Currently, the market remains above all major moving averages, and the MACD is bullish. I see this trend continuing higher. Crude oil futures did see a setback yesterday (Monday, March 17), which I believe was driven by profit-taking. I didn’t see global tensions easing, or interest rates rising. I think it was just a widespread corrective type of day for many commodities.

If you don’t want to buy the top, pullbacks are good times to get in before another leg up. The moving averages are pretty wide in this market. Once this market can’t make substantially higher closes, that’s when we’ll see a bigger liquidation day back down to the key moving averages near $105, $102 or even under $100. Until then, I see the trend as still bullish and would expect to see crude oil prices above $120 by year-end.

If you want to participate in this market, I would recommend farther-dated options, such as June contracts. Options in this market can be expensive, so you might consider a spread, buying a call and selling another against it. You have defined risk and profit potential on this type of trade, but it can be more affordable. This market has been quite volatile, so feel free to call me at 800-803-8037 for more specific recommendations based on the latest price action.

Gold

The chart of gold looks similar to crude oil, and this market finally hit a record peak above $1,000 an ounce this month. Like crude oil, it also experienced a pullback on Monday, March 17.

If you have been sitting on the sidelines during this long term rally in gold, I’d recommend using a correction to $985-$986 as a place to get in on the long side. I’d recommend working some buy orders at $985, $975 and $962 with a stop at $930.

If you have a smaller account, you can consider scaling in with April mini-gold futures or you can consider options. The June 1200 calls run about $1,000 not including commissions, and you close to 100 days to expiration. The $1050/$1150 call spread also offers a decent risk/reward ratio. In general I would recommend staying with the trend in gold unless the market closes below its 50-day moving average. This would help you build a respectable position and give you immediate exposure to a market that has been in a long term bull market.

Phillip Streible and Richard Ilczyszyn are Senior Market Strategists with Lind Plus. They can be reached at 800-803-8037 or via email at pstreible@lind-waldock.com or rilczyszyn@lind-waldock.com. Ask for a free trial to their daily hotline by calling 800-803-8037.

Past performance is not necessarily indicative of future results. The trading of commodity interests entails the risk of substantial loss. Prospective investors should carefully read the Disclosure Document where applicable before making an investment decision.

*No representation is being made regarding the actual or hypothetical performance of the systems at any other brokerage firm or prior to the dates reflected above. These numbers include commissions, but not fees. Contrary to most published results, please note that these monthly returns are calculated based on closed trade profit/loss and do not include changes in open trade equity. Futures trading involves the substantial risk of loss and may not be suitable for all investors. Past performance is not necessarily indicative of future results. All information, including performance and program description, has not been reviewed or verified by Lind-Waldock.