The U.S. Dollar plunged this month, ending the second quarter in its biggest drop in 14 years. Despite this steep drop, it looks like the Dollar decline is still in its early stages and it has a lot further to go on the downside.
This is very important for gold investors because the weak Dollar is the key factor behind the rising gold price. Since gold consistently moves opposite to the Dollar, if the Dollar is headed lower, then gold is going higher. And that makes sense. As investors around the world become disillusioned with the Dollar, for instance, they'll be looking for alternatives and increasingly they'll turn to gold. In fact, it's already happening.
REASONS WHY DOLLAR WEAK
The ongoing record trade deficits, combined with a plunging stock market, and ongoing scandals and company scams have resulted in a terrible drop for the ailing Dollar.
The reason the record trade deficit is unnerving to the Dollar is because the U.S. is the only country in history to be so vulnerable to foreign whims. The bottom line is, the U.S. needs about $1.4 billion coming in every day to finance the deficit, or face a further Dollar fall.
Money was flowing in during the bull market in stocks and the Dollar was king. But those days are over. Foreign buying is down sharply this year and if this continues as we suspect, the Dollar has a lot further to slide.
U.S. interest rates are also lower than in most other countries, which makes the Dollar unattractive. This is another reason why investors are looking elsewhere and it makes it much harder for the Dollar to compete. Plus, the Dollar is overvalued.
DOLLAR: Major decline underway
Massive deficits go hand in hand with a weak Dollar. And as the deficits were growing, the Dollar was forming a major top last year. Our leading indicators were also showing that the Dollar rise since 1995 was at an end and the Dollar was headed lower.
 Chart 1 shows the Dollar's big picture (A) since 1972 along with its leading long-term indicator (B). Note the indicator peaked in 2000 and it's been coming down since then. It led the Dollar itself as the Dollar didn't really fall until this year (see Chart 1A).
Our indicator warned of a major Dollar decline and last month it also broke clearly below its uptrend since 1995. The Dollar itself has now broken its seven year uptrend too. This shows that the Dollar has entered a more bearish phase and it could fall steadily this year and next, down to its 1995 lows as a maximum target, if the 1998 lows are violated (see Chart 1A).
Interestingly, the last seven years have been very similar to the only other strong rise in the Dollar since it began trading in the free market. The other rise occurred in 1978-85 and it also lasted six years. In both cases, the Dollar rose in a 1 through 4 pattern. The last 1-4 rise ended in a huge 46% fall in the Dollar in 1985-87 (see #5 on Chart 1A).
As for gold, it soared 72% during the 1985-87 Dollar drop. If the upcoming Dollar bear market is similar as the 1 through 4 pattern suggests, then the current bull market could reasonably take the gold price to about the $440 level.
Now we're not saying the current Dollar decline will repeat in a rubber stamp way but the similarities between then and now are striking. Based on the deficit alone, for example, the Dollar could drop 40%. Manufacturers figure the Dollar should decline about 30%.
The Dollar has already fallen about 18% this past year and it's well on its way in a major decline. If it ends up falling 40%, which is not unreasonable, it would take the Dollar down to the bottom of the multi-decade downchannel, which would indeed be similar to 1985-87 Dollar decline and very bullish for gold.
For now, the dominos are falling. The September low in the Dollar was broken, the 1995 uptrend was broken and the January, 2001 low was broken. This is weak action and the Dollar index will now remain weak even if it bounces up to the 113 level. The major trend is down below 116 and as long as the Dollar stays below that level in the months ahead, then gold is headed higher.
Taking the next moderate bull of 1985-87, it produced a gain of 72% in almost three years. This means a similar moderate bull today could reasonably take the gold price to the $440 level.
Mary Anne and Pamela Aden are internationally known investment analysts and editors of The Aden Forecast, a market newsletter providing specific forecasts on gold, gold shares and other major markets. Click here to visit their website at http://www.adenforecast.com
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