Daryl Guppy

Lubricating the wheels of the economy

By Daryl Guppy (China Daily)
Updated: 2011-03-28 12:58

Investment world experiences significant change of attitude

Japan continues to struggle with a nuclear disaster on top of the devastation of the earthquake and tsunami. The Middle East is descending into tribalism and civil war. These are the perfect conditions for a rise in the strength of the US dollar and a dramatic rise in the price of gold. But neither of these reactions are occurring.

We can speculate on the reasons for this diversion from expected behavior but that does not assist with investment decisions. It is more useful to analyze the behavior of the US dollar and gold to decide where investment funds are best allocated. It's not useful buying gold if the price has limited upside.

There are three developing relationships that highlight a change in the flow of investment capital. They are the US dollar, gold and oil .

The downward trend with the US Dollar Index has gained more momentum. The next support level is near $0.755. This is substantial dollar weakness and confirms the move away from the US dollar as a haven currency. The downward trend is strong and this has the momentum to drop even further and potentially re-test the lows near $0.72.

A weaker US dollar has a significant impact on global investment and trade flows. The flow of money into high yielding currency investments increases inflationary pressures. Coordinated efforts by G7 countries to manage the Japanese yen are frustrated by the continued weakness in the US dollar because investors and currency traders will not willingly give up profits and profitable opportunities.

When the US dollar falls then gold goes up, according to standard analysis. Chart analysis shows this has not been correct for more than two years. The correlation between the gold price and the strength or weakness of the US dollar was broken in October 2008. The current activity confirms this break with gold struggling to stay above the triple-top resistance level at $1,430 and the technical price target at $1,440.

The gold upward trend has not ended but it has lost a large part of its strength. The longer term upside target is near $1,520 but the move to this level has the characteristics of a slow trend rather than a fast rise on the back of global instability.

Related readings:  Hard blow to Japan economy  Rocketing world oil price fuels up China's price-hike momentum  Fighting soaring oil prices and inflation  Radiation fears clobber Japan outlets

So where is investment capital going if it is not into gold as a safe hedge against currency weakness, political instability and global fears? The activity of professional hedge fund managers helps to confirm the changed investment environment and potential destinations for investment funds. The hedge funds have been buying energy-related stocks and selling exchange-traded funds (ETFs), financial, materials and industrial stocks. Hedge-fund selling of ETFs last week was more than three times the average for the previous four weeks.

Hedge fund investment in energy-related stocks more than doubled last week compared with the four-week average. The switch to energy and, particularly, oil-related stocks and futures will help to further increase the NYMEX oil price. It's a typical acceleration of oil price behavior once the psychological $100 barrier is breached.

There are two important price levels for oil. The first is the psychological support level at $100. Once above this, the volatility of oil pricing increases. Upward moves and downward moves become more rapid. Additionally the range of price movement becomes more extreme, with oil moving quickly towards $110 and then to the next target near $124.

The second important price level is the value of the upward trend line. This is currently near $90. This shows that the oil price could fall to $90 and still remain within a long-term upward trend.

The oil market offers excellent returns for speculators, investors and for the commodity funds that provide investment speculation opportunities. When global capital is looking for a home in today's market it is going to the volatility of commodity markets and capital gains rather than the safety of gold or the US dollar. It's a significant change in thinking and chart analysis provides the evidence.

The author is a well-known international financial technical analysis expert.