Buying Gold or Silver? Watch This Chart

Everyone loves a winner. That’s probably why I get more questions about precious metals than any other investment.

Since 1971, when President Nixon ended the fixed relationship between gold and the U.S. dollar, gold has returned about 8% annually to investors. By this measure, gold has underperformed U.S. stocks, which produced an average annual return of about 10.7% over that same period.

While 8% might not sound exciting, in recent years gold has started to shine. Last year, gold gained just over 13%, and this year, investors have reaped an 18% return. We captured a nice move in gold earlier this year.

Ever since the relationship between gold and the U.S. dollar was severed, the greenback has served as an indicator. Since commodities like gold are priced in dollars, a falling dollar tends to lead to rising commodity prices. Simply put, if the dollar falls, things that are valued in dollars tend to rise in price.

When we look at the chart of the U.S. dollar right now, the recipe for higher commodity prices, including gold and silver, is revealed. The U.S. Dollar Index (DXY), which charts the greenback against a group of foreign currencies, is on the verge of a breakdown. 

There are three bearish aspects to this chart:

1. The U.S. Dollar Index has broken its bullish trendline (black dotted line), which held firm for the first six months of this year.
2. The index has fallen below its 50-day (blue) and 200-day (red) moving averages.
3. A bearish double top pattern (shaded yellow) is now visible on the chart.

My interpretation of this chart is as follows: There is a higher-than-normal probability of a breakdown in the U.S. Dollar Index, and if that happens, there is a increased probability of a rally in gold, silver, and potentially other commodities like oil.

If I sound like I’m hedging my bets, it’s because inflation has been a driving force behind the appreciation of precious metals. With annual CPI inflation falling to a lower-than-expected 3% in June, and with a rate cut nearly fully priced in for September, there is a counter-argument to this thesis. 

As of Monday afternoon, the odds of at least one September rate cut stood at 98.1%, according to the CME Fedwatch Tool. There is just a 1.9% chance of the Fed Funds rate remaining at its current level. That meeting begins on September 16, just two months from now.

What does that mean for investors? Keep an eye on the U.S. Dollar Index. A breakdown in the dollar would likely set in motion a bullish series of events for precious metals investors. 

At the time of publication, Ponsi had no positions in any securities mentioned.