The Currency War Heats Up

While gold sits on the sidelines...

AMID CONTINUING inflationary policy, the US Dollar is at a critical juncture by both daily and weekly charts, writes Gary Tanashian in his Notes from the Rabbit Hole eletter earlier this week.

Currency war kicks off; gold just sits there biding time.

From last week's eletter:

"A Goldilocks atmosphere was expertly created in large part due to the fact that Operation Twist (yes, we are still dealing with its effects) by its very definition held long-term interest rates down (buying long-term T bonds) while sopping up any money supply implications and inflationary signals by sanitizing the process with the sales of equal amounts of short-term bonds."

Policy makers have not found a new way to indefinitely manage the economy.  Traditional laws of economics have not been repealed.  The Federal Reserve used the equivalent of a macroeconomic parlor trick to dampen inflation signals and help produce today's Goldilocks atmosphere, which features stocks rising now that the public and its mainstream money managers feel the worst is over with respect to the fiscal cliff non-event and the debt ceiling noise.

But in economics and macro finance, there is always a price to be paid for unnatural (read: man-made) distortions.  The Fed ran out of short-term bonds to sell and now something has to give, as its ongoing inflationary operation is now unsanitized.

A bearish Head & Shoulders pattern has formed on the currency for which the Fed is supposedly a steward.  

The weekly chart of USD shows an even more significant H&S, with the baby H&S of the first chart merely representing the right shoulder of the big daddy H&S.

A breakdown in the US Dollar would confirm that the recent tick higher in Adjusted Monetary Base is the beginning of a new trend up in inflationary policy.

Unsurprisingly, USD's chief rival, the Euro is in an inverted and bullish H&S.  The Euro appears to be attracting a 'long Euro/short Yen and gold' momentum (read: hedge funds) crowd playing the opposite game to that from mid-2011 when Yen and Gold rose strongly in reaction to the Euro crisis.

The Yen has been played to the hilt by hedge funds.  The Yen could be a heck of a contrarian play for a counter trend rally, as the short-covering should be massive.

Meanwhile, the currency that resides outside the system bides its time.  Gold is unofficial money and with all the hype about currency war people who are not patient may have expected a rocket launch in the precious metals.

Here we bring it back to the Euro and realize that too many unhealthy would-be gold bugs came aboard during the acute phase of the Euro crisis in 2011.  That is being worked off now in gold's ongoing consolidation.

In the near-term some currencies are bullish and some are bearish.  But the US Fed, Europe's ECB and the BOJ are not going to engineer their way out of their respective 'inflate-or-die' predicaments.  Gold may have a few more months of correction/consolidation but that is a drop in the bucket when viewing its entire history as a monetary anchor to value.

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