There has been a close relationship between gold and the U.S. dollar recently. If you trade either market, it would be prudent to keep an eye on the other. I’ll share some of my thoughts about gold, the U.S. Dollar Index and the inflation picture, as well as where I think these markets may be headed next.

Both gold and the U.S. dollar have made historic moves in the past month. The COMEX February 2008 gold futures contract peaked at $855 an ounce on November 7, 2007, which you can see on the chart. Looking at the December Dollar Index chart, we can see this index hit all-time lows at 74.65 back on November 23. The index is traded on the ICE U.S. Futures Exchange and represents the U.S. dollar’s standing against a basket of 6 different currencies.

In recent days, each of these markets has seen corrections from these historic levels.

Gold has corrected back from that $855 high to a low of $783 on December 3, 2007. This market has seen a decline of about $72 in less than a month—that’s pretty significant. Gold futures have bounced off major support at the 50-day moving average, and also at $780.40, a swing low.

The U.S. Dollar Index bounced back to old resistance, just as the gold did to old support. The Federal Reserve is set to meet on December 11, and it looks as if a rate cut is looming, based on recent comments from Fed Chairman Ben Bernanke and others.

If the Fed continues easing interest rates this month, I feel the dollar’s recent gains will be short-lived, and it will likely re-weaken. This should translate into buying opportunities for gold, and selling opportunities for the U.S. Dollar Index, and that’s the strategy I’m recommending right now. The trend in the dollar is literally straight down, while the gold has been steady up, and I don’t see those trends changing overnight.

Lower interest rates tend to weaken the dollar as it reduces the currency’s interest rate appeal. Based on economic numbers in Europe, the European Central Bank is expected to keep its rates steady, which makes interest rate differentials even more appealing for the euro, a higher yielding instrument. I do feel this has been priced into the U.S. Dollar Index futures, and long-term I see this market bearish.

Inflation has also been a concern affecting the dollar, and I see it remaining a threat. For example, crude oil tried to attack $100 a barrel and failed. Although this market also has experienced a correction, I think it’s only a matter of time before we do see $100.

I believe it’s a good time for both short-term and long-term traders to set up positions in the gold and Dollar Index futures. Short-term for gold, I would recommend buying the front-month contract, and risk the swing low/50-day moving average support levels at about $780. If this level breaks, however, I’d exit the trade and rethink my posture. You can also trade the mini gold contract, which is a third the size, if you have a smaller account.

Long-term, I’d consider buying call options in gold. I recommend buying COMEX Feb 850 calls, which are about $1,200 a piece, and expire on January 28, 2008.

I suggest contacting me for more specifics in terms of trade strategies. I’d be happy to tailor a strategy for your specific account size and risk tolerance.

Ben Kim is a Senior Market Strategist with Lind Plus. He can be reached at 800-355-5757 or via email at bkim@lind-waldock.com.

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