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Conventional wisdom has
it that there are three safe haven currencies—the Swiss Franc, the
Japanese Yen and the U.S. dollar. But perceptions are changing. The US dollar
is no longer the default shelter for long-term investors. Instead, the Swiss
franc and the Japanese yen have been the hideaways in a financial storm along
with history’s longest used currency—gold. But both the Swiss and
Japanese governments are desperately trying to curtail their currencies
appreciation and to curb the inflow of investments by selling their
currencies into the market and creating an oversupply, which will lower
prices. They have both cut interest rates to zero. A strong currency makes it
difficult to export your country’s goods.
It’s easy to understand why investors have
perceived the Swiss franc as a safe haven. Switzerland boasts a strong
economy, which is not plagued by high national debt and budget deficits. With
its conservative Swiss banking monetary policy, it has not resorted to money
printing schemes with names like “quantitative easing.” The Swiss
franc reached milestone parity with the dollar in 2011 and since then has
appreciated by an additional 20%. The franc is up 5.41% against the euro this
year and almost 14% against the dollar.
However, last Tuesday, the Swiss franc plunged
dramatically versus the euro and other major rivals after the Swiss National
Bank took the extraordinary step of setting a floor for the euro/Swiss franc
exchange rate at 1.20 francs and vowed to buy “unlimited
quantities” of euros to defend it.
Needless to say, this gave gold a boost. It reached
a record of $1,923.70 an ounce in trading Tuesday of contracts for December
delivery, before retreating below $1,900. The price of oil has fallen because
of the global slowdown, eliminating another place where investors might be
tempted to stash cash. The SNB's move was widely viewed as positive for gold
because the metal will gain even more popularity as a safe-haven investment
of choice.
For the past 14 months the franc has experienced a
parabolic rise as financial instability beset many of its neighbors as well
as the US. The move by the SNB puts the central bank in direct conflict with
a strong desire by market participants to buy safe-haven assets. Since there
is a good chance that the eurozone crisis will only
get worse, the Swiss intervention could prove to be very costly to the SNB.
The move underscores the particular challenges facing Switzerland at a time
of global economic uncertainty.
This is not the first time the Swiss central bank
has resorted to such a strategy to contain the franc. It used a similar
strategy in the late 1970s to weaken the currency against the Deutschmark.
The central bank’s new target commits it to buying euros and selling
francs any time the euro falls below 1.20 francs. That amounts to setting a
floor for the euro or a ceiling for the franc.
What is true in the long-term does not necessarily
have to be valid in the short-term. Even though the long-term outlook for the
dollar is rather cloudy, investors have been buying large amounts of dollars
in the last few days. It seems that the fact that German officials
reluctantly start to admit that a Greek default may be the only way to
resolve the current crisis of the euro has coerced investors into buying the
greenback rather than gold and the Swiss franc.
Why is that? One way to explain this is to point to
the recent depreciation of the franc against the dollar. The aforementioned
peg of the franc to the euro has affected the USD/CHF exchange rate as well.
This means that, at least in the short term, the franc is less attractive
that it was a couple of weeks ago. If you couple that with the recent
parabolic rally in gold and the fact that investors and traders start to
doubt whether gold is poised to continue its move up in the short-term, you
may come to the conclusion that in the short-term the dollar has recently
become more attractive. This is why we currently see a considerable movement
of capital from the eurozone to the USA.
All of the factors mentioned above have added to the
recent move up in the USD Index. To see how this may influence the precious
metals sector, let’s move on to the technical part of today’s
essay. We will begin with the long-term Euro Index chart (charts courtesy by http://stockcharts.com).
The index moved sharply lower this week, and it is
now below the declining resistance line marked with red on the above chart,
which opened the door to significant declines towards the 135 level. If the
downward move continues, the index may move to the level of 130 or even
lower. This week’s developments will likely have further positive
implications for the dollar.
In the short-term USD Index chart, we saw the index
break above the declining resistance line last week. This short-term move in
fact created a breakout from the long-term perspective as well.
This has become a bullish signal since this move
ignited a move above the long-term resistance line which in turn will likely
ignite a rally from a long-term perspective. The hitherto rally has brought
the USD Index levels up to as high as 77-78 and the move is likely to
continue to the level of 80 or even higher. All this will likely have
negative implications for the precious metals sector.
Please, recall what we wrote on September 7th
in our essay on gold and the Swiss franc:
(…) the
recent appreciation in the euro seems to be short-lived and we currently do
not view it as a bullish signal for precious metals. The following rally in
the USD Index took the dollar above the declining trend channel, which
– if confirmed and no additional factors emerge – will likely
correspond to a decline in the precious metals.
This is precisely what followed – the euro
retraced and declined further, the dollar rallied and the PMs moved lower.
Combine that with the fact that the move in the USD Index was significant and
that it appears to be an early part of a bigger move up. This is where
medium- and long-term correlations come into play and these are negative for
the dollar and the precious metals sector. Consequently, the precious metals
sector is likely to move lower based on dollar’s rally.
Summing up, the situation in the USD Index is bullish this week
and quite the opposite is true for the Euro Index. The latter declined
sharply this greatly contributed to the positive moves of the dollar. The
short-term implications for precious metals are bearish.
The influence of these currencies is likely to be
very visible throughout the precious metals sector. It appears that the key
signal to watch for this week is whether the USD Index can retain its upside
potential. This would greatly increase the probability of lower precious
metals’ prices in the weeks ahead. While this is pertinent to the
short-term, the long-term outlook (following years) for precious metals has
not changed and remains bullish. We advanced arguments in favor of such a
point of view in our recent essay about the comparison between two gold bull markets.
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Thank you for reading. Have a great and profitable week!
Przemyslaw
Radomski
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