Gold, Euro, and the U.S. Dollar

by Greg Perlin and Mike Marshall

The relationship between the U.S. dollar and gold is nothing new, but what about other outside markets? What does euro have to do with precious metals?

The euro has been one of the strongest safe-haven bids in recent months, as we have seen the dollar take a tumble. Yet going forward, I believe that the dollar is due for a period of strength. Not necessarily because the Federal Reserve will be raising rates in the near future (which they may be forced to do because of mounting inflation pressure) but more so because the European Central Bank (ECB) has held rates steady during this time of Fed easing.

In a recent Bloomberg article, the ECB stated that they will be offering 75 billion euros in the form of six- and three-month loans to banks. This marks a big step for Jean-Claude Trichet, head of the ECB, and its policymakers. A sign that they believe that the current financial crisis will continue to be a drag on the global economy well into next year could be seen as a precursor to an ECB rate cut. If they are admitting that they believe an injection of liquidity may be necessary, how far off are they from entering an easing cycle? We believe that the ECB has held out too long in cutting rates for their own good. True, inflationary concerns remain for Europe as well as the U.S., but perhaps Trichet should be taking a lesson from Bernanke and the Fed. Maybe if the Fed hadn't waited so long to begin cutting rates in the first place, we might be in a better place than we are at the moment.

We feel that it's only a matter of time before the Europeans begin to feel the full effects of the credit crunch that has tightened lending standards in the U.S. and led to the inevitable weakening of the US dollar. In market action Monday, March 31, 2008, the June euro futures contract pushed to a new high of 1.5843, only to fail above previous highs, and is currently trading around 1.5590. A continued decline from here (be it from ECB rate cuts of simply a rebalancing of the currency markets) should push the U.S. dollar higher.

We think that a stronger dollar will provide the impetus needed to push precious metals lower. We are still big gold and silver bulls, but belong to the school of thought that preaches patience, and waiting for the right move. Aggressive traders may want to short metals in the coming weeks, but for those who wish to wait for a buying opportunity, we recommend patience. Metals may continue to correct lower.

After a move lower in the euro, and the subsequent bounce in the dollar, many investors and traders may begin to question which market will become the next safe haven. For many out there, this idea is nothing new, but we feel that when faced with a global economy where several countries are forced into lowering rates to ease credit tensions, investors will come to see gold and silver as the next stable currency.

A correction in metals and also the energy market seems to have started already. Recent price action has taken the June COMEX gold contract $140 an ounce off its mid-March highs. Strong support at the 50-day moving average has been broken in last Friday and Monday's trade, and with the market closing below the 9-day moving average, the short-term trend is still negative.

Trade Strategies

The first move to make is to get positioned for a break in the euro. Given the instability in the markets, we are recommending a relatively low-risk euro trade that offers a good return potential. We are recommending a 1:3 option ratio spread, as follows.

Buy 1 June 2008 euro 1.550 put

Sell 3 June 2008 euro 1.490 puts

Your net price paid is around 9 cents (9 x $12.5 = $112.50) – maximum risk if the June euro futures go higher. The current initial margin is $810.

This trade would be profitable between 155 and 146 in the June 2008 euro. Below 146, the spread begins to lose money. However, we would recommend selling futures or taking profit on the spread after the 1.49 mark is breached in the June 2008 euro.

Aggressive traders may want to look at yet another ratio spread which could involve more risk, but one that leaves the upside open. We recommend a strategy of selling the 160 calls because the previous high in this market was just short of 158.50.

Sell 1 June 2008 euro 1.600 call

Buy 2 June 2008 euro 1.510 puts

This trade should be entered at even money or better. The risk with this trade is potentially unlimited due to the fact that if the June 2008 euro goes higher, you are short a naked call. The advantage to this trade is that if correct, the upside is unlimited and the short calls will expire worthless. We like both of these trades, but given recent volatility, we would prefer to look at the less-aggressive trade of the two recommended above. The great thing about these trades is that they do not use the same strikes. So, if you are looking for a combination of the two strategies, you would still be able to enter both trades.

We are aware that many traders like to work their trades online, but we recommend placing your trades directly down to the currency pits for these strategies. By using the direct-floor access that we provide through Lind-Waldock, trades are filled as a whole price.

Going Forward

As we have said above, after the break in the euro market, we are looking for a long-term buy in the gold and silver markets. We are very bullish the metals right now, but the best advice we can give is to have patience to wait for the right time to trade, and the conviction to follow through with your ideas. With silver dealers around the globe currently running out of silver to deliver, we think it's only a matter of time before we see a return to higher prices. Given market fundamentals, we could easily see silver prices topping $50 an ounce in the coming months and years. We'll be talking more about the silver market in the coming days, so stay tuned!

Greg Perlin is a Senior Market Strategist with Lind Plus. He can be reached at 800-437-4189 or via email at gperlin@lind-waldock.com.

Mike Marshall is a Market Strategist at Lind Plus. He can be reached at 800-437-4189 or via email at mmarshall@lind-waldock.com.

Past performance is not necessarily indicative of future trading results. Trading advice is based on information taken from trade and statistical services and other sources which Lind-Waldock believes are reliable. We do not guarantee that such information is accurate or complete and it should not be relied upon as such. Trading advice reflects our good faith judgment at a specific time and is subject to change without notice. There is no guarantee that the advice we give will result in profitable trades. All trading decisions will be made by the account holder.

*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.