How Gold Links Treasuries & the Dollar

US Dollar & Treasuries. The emergence of last week's unsual direct relation between the dollar and gold provided a valuable signal to the validity of the rally in the precious metal. It could also be explained by the rise in bond yields (fall in prices). Last week witnessed a rise in bond yields that was accompanied by a not-so smooth strengthening in the value of the dollar. Despite the dollar's leap to 23-year highs vs GBP, the currency made more modest gains vs the euro while nearing 14-year lows against the yen. The dollar's gains proved sketchy at best as the rise in bond yields emerged from supply concerns (excessive borrowing) rather than improved economic data. Yields on 10-year treasuries hit 6-week highs as the Obama Administration is expected to step up the nations borrowing to a new record high, taking the fiscal deficit to as high as $1.4 trillion or (9.5%-9.8% of GDP). This week, auctions of 2-year notes, 10-year notes and 20-year TIPS will raise $78 billion. As the dollar is unable to fully respond to rising bond yields resulting from supply worries, gold prices take over the mantle of safety.

Gold has comfortably held above the $900 level as the unusual decoupling with the euro (and unusual coupling with USD) continues due to the metals improved luster resulting from widespread global economic gloom and ultra low global interest rates. As the price of money (interest rates) is held down by central banks, the price of its competitor (gold) pushes higher on the lack of yield reward in monetary alternatives, excess printing by Fed, BoE & ECB as well as the absence financial market shocks (which have proven negative for risk appetite as well as gold).

My Friday outlook for $900 gold was especially highlighted by the notion that gold remained lower in yen terms than in terms of USD, GBP or EUR, thus, more likely to lure Japanese investors into lifting the metal towards the YEN 82,000, which is technical resistance. As this ensues, retail investors worldwide begin to chase the headline-grabbing trend (+$900) and drive the metal further up. While having breached well above its 200-day moving average against both the euro and the dollar, gold remains 11% lower than its 200-day MA in yen terms. Reports of gold shortages in popular gold shopping places such as Dubai have are also starting to provide the real demand element to the rise in spot price of gold. Despite golld's breach above the psychological level of $900, The $920 trend line resistance remains the more essential target to break. Tuesday's release of the Germany's January IFO survey on business sentiment may well be teh catalyst for further gains in GLD and EUR in the event that both the expectations and current assessment indicators meet or beat forecasts.

Wednesday's FOMC decision will no longer carry the usual suspense associated with the size of the rate cut after the FOMC clarified it will keep rates near zero for some time. Instead, the quantity of bonds purchased will be the new focus as the Fed implements the Term Asset-Backed Securities Loan facility, which case Treasuries may stabilize, yields weaken and the dollar ease lower.

Euro has a firm grip above the $1.29 figure after last week's successful stabilization at the $1.2760 low kept bears at bay despite the latest S&P downgrade of a Eurozone member. Tuesdays IFO survey will be mulled for its components as both the current conditions and expectations index will have to show declines in order for EURUSD to fall markedly. EURUSD is unlikely to repeat last weeks wobbly tone especially ahead of the zero-bound FOMC. Trend line resistance remains firm at $1.3250, followed by the 50-day MA of $1.3320. EURGBPs 6-day rally is being reversed amid a partial pick-up in risk appetite. 0.9275 is seen as a temporary support that could be broken only in the event of accumulated buying in global equities.

GBPUSD made its obligatory bounce from the latest 23-year low of $1.35, but gains are increasingly capped at $1.3980. The main drivers of any sterling rebound are seen as technical buying, overall USD selling on Fed credit easing and the resulting bounce in risk appetite. Subsequent gains could emerge towards $1.4070.

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