The gold market has for some time been closely tied to its inverse relationship to the US dollar.  The relationship, created by gold being priced in US dollars and thus offering varying demand shifts by foreign investors based on their local currency's relationship to the US dollar, has recently been neutralized.  The US dollar's 10% surge has had much less of an effect on gold prices as one would have thought or that I had forecasted, forcing many analysts to wonder why gold has entered the twilight zone and question what is pushing that market's price movement.  Let's take a look at a few theories, and then I will tell what the cause really is.

Theory #1: Market Manipulation

Almost every gold bug I have ever encountered, whether gold is rallying or selling off (but especially when it is selling off) uses the concept of market manipulation, albeit by differing sources such as the US government, oil dominated countries, etc., to explain the unexpected or non-conforming price moves in financial related markets.  The bottom line is that this an inherent part of all markets, and manipulation is just another word for buyers and sellers.  A great example of this is stock market price support.  For a long time the market appeared to find support during bear breaks with little bullish news, pushing the analysts and market speculators to suggest government manipulation as the cause.  But as time went on, and the growing public awareness of fund and institutional automated buying and selling programs increased, the market became more comfortable with the idea that large volume participants were the underlying cause of these unknown price shifts and supports or resistance areas.  Price manipulation is not the underlying cause of gold's apparent price stability during US dollar strength, it is just a word that speculators use to excuse being wrong.

Theory #2: Gold Is Trailing the US Dollar Move (waiting for confirmation)

This is definitely something I would say - if I believed it to be true.  The gold market has a long history of getting ahead of US dollar moves and lagging beyond others, and would often appear in hindsight to have offered great trading opportunities simply playing this relationship.  In my analysis and experience I have this event to take place during three different market scenarios: 1) Choppy or range bound trade - the gold market consistently trails or lags the US dollar move when the US dollar is range bound or channeling, as the market psychology is often structured around avoiding getting ahead of itself in this type of market condition.  2) Approaching critical support or resistance - The gold market stalls its trend when a major point of US dollar support or resistance is nearby.  This forces the market to play catch-up when this support or resistance is broken, but otherwise the market has lagged or held back from overly committing to the move.  3) Market weariness - the market grows uncomfortable with trading action that suggests a lack of follow through on major moves (such as what we are witnessing in the stock market).

The problem here is I just don't see any of these three events taking place.  The US dollar clearly broke out, no major price resistance is nearby and the market is witnessing a major trend reversal for the first time in three years - REACT!

Theory #3: Gold Is Shifting to a Non-correlated Market to US Dollars

A good theory, and one that will eventually come true, is that gold is becoming less and less correlated to the price shifts of the US dollar.  Once this occurs, the market is free to trade on true supply and demand fundamentals, flight to quality issues, global politics, etc.  This is certainly an ideal theory and one that will most likely occur in the distant future, but only when the US dollar stabilizes.  In a decade the US dollar has risen 50% and fell 33%, the later move in under 3 years!   This is not indicative of a stable market environment.  As long as gold prices move in the view of foreign investors (as their currency becomes more or less valuable) then the gold market will continue to have a strong correlation to the US dollar price movement.

The Real Underlying Cause

Many other theories are out there, but the one that works - that puzzle piece that fits perfectly into that opening without having to jam it in there is the interest rate dilemma.  Let's just talk common sense for a moment.  A strong dollar is typically caused by a strong or improving underlying US economy.  A strong US economy typically means rising rates and lower bond prices.  Over the past several weeks we have witnessed a massive bond rally while simultaneously witnessing a bull breakout in the US dollar.  So which is it?  Is the economy getting weaker?  Is the dollar strong or is the euro weak?

When France bailed on the EU constitution the world woke up and paid attention.  This was a massive blow to system that has been gaining global support and building seemingly permanent strength.  The euro is reeling from this.  Here is a currency market that has grown 50% plus from its inception and now faces its first major blockade in its plight for global currency dominance.  The euro is clearly in trouble, and this means a strong dollar - but does that mean anything else should change?  The Japanese, and Asia in general, have long been accepted as big time buyers of gold in the world.  While the Saudis own a bunch of it and the US plays the game, the Japanese are always there buying when they spot value.  Since the US dollar bottomed and began it's rise to today's prices, the euro has dropped slightly more than 10% from its highs.  During this same time frame the yen has dropped less than 4%.  What we are really witnessing here is a global currency market that is not seeing the same move as the US dollar/euro relationship and thus gold is not reacting.  The US dollar index is comprised of many currencies, but weighted over 50% by the euro, and thus we see the US dollar move on euro swings but less on yen moves, or pesos or Canadian dollars for that matter. 

This twilight zone we have entered into with gold is short term.  The dollar will force its will upon the global currency market and the EU issues will fade as the cause of the next move.  When the dollar breaks to fresher highs it will be because the dollar is strong.  This will happen when bonds drop and interest rates rise and the market realigns itself with proper inter-market correlation.  I wouldn't be surprised if this happens in the coming weeks so take this as an opportunity to get short gold $20 higher than it should be and watch the market return from the Twilight Zone.

James Mound, owner of JMTG Brokerage LLC, MoundReport.com and author of the book 7 Secrets, writes the Weekend Commodities Review Newsletter. Receive your free weekly subscription to the Weekend Review by e-mail. Click here.