Over the past month or so I have been pointing out in this Report that gold’s near term fate lies with how the European Union (EU) and International Monetary Fund (IMF) handle the Greek sovereign debt issue. Unfortunately as of this writing there has been no real resolution. In my opinion the EU has allowed contagion to spread to other parts of the EU and world financial markets.

The marketplace is testing the resolve of the EU. Whatever the final plan or outcome for Greece turns out to be, right behind it are issues with Portugal, Spain, Italy and Ireland. It also appears from early polls in England that England is about to have a hung parliament, which could ultimately bring England’s economic outlook into question.

Eventually and for whatever reason, a relief rally will occur in the Eurocurrency. I don’t expect it to hold when it comes, but it can be large and swift. Over time I can make an argument for the Eurocurrency to fall down to the 115-120 price zone but in my opinion the first downside target of 1.2500 has been seen.

If Germany were to vote to not support the EU-IMF Rescue Plan, that event might well spell the end of the EU. These are interesting times, but regardless of the short term outcome, I expect over time to see continued selling pressure on the Eurocurrency.

A weak Eurocurrency brings with it a strong Dollar Index. A strong Dollar Index can be at times bearish commodities and at other times not matter to gold.

Some may argue that a strong Dollar has been one of the reasons gold hasn’t been able to surge. Breaks in copper and silver have been pronounced as both of these metals are more closely related to economic activity than safe haven buying, which gold represents. Given China’s intent to slow down its economic activity and the chaos in Europe, industrial metals like silver and copper are being negatively impacted.

It’s my belief that because of the uncertainty in Europe, safe haven buyers have been running to US Treasuries and the US Dollar. Look at today’s huge break in the US stock market and at how the Dollar and treasuries performed during the break.  

The yield on 10-year notes has gone under 3.5%, a yield not seen in a very long time. The Dollar Index is trading at 85.00.

In November 2009 the Dollar Index was trading near 74.00. Gold last November was $1100 an ounce. It’s hard to deny that gold and the Dollar Index are rallying together.

I think gold has a double edge sword going for it in terms of fundamentals. If the Euro Union breaks up investors will probably turn to gold as a safe haven. If the Eurocurrency holds together and rallies due to Germany “saving the day”, the Dollar Index probably breaks,  which in turn may support gold prices in the longer term, but in the short term cause safe haven investors to dump gold.

Not all of Europe is in financial trouble. In fact the EU’s largest member, Germany, has a healthy economy. The question for Germany is how much they want to take on given the likelihood of more debt issues with other fellow EU members. Germany also has to weigh the benefits of not having a Eurocurrency or supporting a Eurocurrency that has different members. I feel certain these are all factors being taken into consideration by Germany.

The trend on the above chart is up but prices are over the Bollinger Band Top which I interpret to be a warning signal that prices either have to run and keep running right now or pull back and consolidate.

Below is a Daily Chart of June Gold. Each individual bar on the chart represents one day of trading. In “red” I have plotted the 18-Day Moving Average of Closing Prices, in “dark blue” the Swingline Study and the “black dashed line” is the Bollinger Band Study.

The Swingline Study is displaying a chart pattern of lower lows and higher highs, which is not an “ideal” bullish chart pattern. The fact that the market made a “higher high” as its last move means the momentum, aka the trend, is up.

Just yesterday prices fell down, broke through the previous low but held the 18-Day Moving Average of Closes. The key yesterday was that prices closed over the 18-Day Moving Average of Closes, which in my opinion stopped a downtrend from technically occurring. One of the chart analysis rules I teach is that the Swingline Study is filtered by the 18-Day Moving Average of Closing Prices. If the Swingline is pointing down, prices must close under this moving average to confirm that the Swingline Study is in a downtrend. This did not occur.

Without taking today into consideration, the Swingline pattern was that of a “lower low and higher high”. The Dollar risk from low to high point was 1156.2 up to1192.8, an approximate $36 difference in price which meant that had one gone short, their initial risk as I teach it would have been $36 an ounce, a risk that immediately disqualified this break as one to be short on.

Today prices today rallied up and through the previous rally high of 1192.9. There are a key differences from yesterday. First, prices made a new rally high. Second prices closed over the 18-Day Moving Average of Closes. In pure Swingline terms, this confirms a bull trend.

The Dollar Risk as I teach it is from the current price down to one tick under the most recent Swingline Low, which equates to 1156.1. That is an approximate risk of $40 an ounce, which once again filters out the idea of getting long at current prices.

Last, ask yourself where prices are in terms of the top Bollinger Band. They are trading over it. Statistically speaking, if you set this band using a standard deviation of 2 from its mathematical mean, prices in theory only trade above the upper band or under the lower band two and a half percent of the time.

Take a look at how the Dollar’s relationship with gold is going.

The Dollar is moving in synch with gold while the Eurocurrency is also doing so. However the Euro has an inverted relationship, which makes sense given the dire situation the Euro Union finds its members in and the impact sovereign debt issues have had on the Eurocurrency.

Today’s historic break in stock index prices along with the EU’s problems turned gold prices up and helped the shorter term daily chart, turn bullish.  I expect to see support on breaks back to the $1170 to $1175 price level.

Gold has momentum and reasons to move up to its all time high. If it doesn’t and if prices were to get under $1156.2 a change in both trend and trader’s attitude could be at hand.

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Disclaimer: This publication is strictly the opinion of its writer and is intended solely for informative purposes and is not to be construed, under any circumstances, by implication or otherwise, as an offer to sell or a solicitation to buy or trade in any commodities or securities herein named. Information is taken from sources believed to be reliable, but is in no way guaranteed. Chart data is courtesy of LGP-IraCharts. No guarantee of any kind is implied or possible where projections of future conditions are attempted. Futures and Options on Futures trading involve risk. In no event should the content of this market letter be construed as an express or implied promise, guarantee or implication by or from The Ira Epstein Division of The Linn Group, Inc or The Linn Group, Inc. that you will profit or that losses can or will be limited in any manner whatsoever. No such promises, guarantees or implications are given. Past results are not indicative of future performance.

-- Posted Friday, 7 May 2010 | Digg This Article