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It has been widely assumed across the
markets that the forces of deflation have been vanquished by the Fed’s making
it plain a couple of weeks ago that it is going to throw all of its firepower
into the battle to defeat it. So let’s make this as clear as possible
– the forces of deflation will not be defeated by anything until they
done their work of expunging the massive overhang of debt from the system.
The Fed’s latest stated policy is merely a display of desperation and a
symptom of intellectual bankruptcy in that they seem to think that more of
what created the problems in the first place is now going to somehow fix
them. We are going into a depression anyway, and they have made it plain that
for good measure they are going to destroy the currency into the bargain. In
reality, all they are trying to do is buy as much time as possible –
they know they are cornered and that the system is doomed and procrastination
is all that is left to them.
Anticipation of the QE to eternity proclamation by
the Fed drove the dollar down steeply, and simultaneously drove the Precious
Metals higher. After the announcement was made the dollar crept higher as the
dollar unfriendly news was then all priced in and it was oversold and
entitled to a relief rally, and at the same time the Precious Metals trod
water, moving sideways.
Right now the belief is widespread that the dollar
has just completed a “bear Flag” and that another vicious downleg is starting, which will synchronize with a big
rally in the Precious Metals, that many investors have positioned themselves
for, but we are instead seeing important and compelling evidence that before
the dollar continues much lower it will first stage a significant
countertrend rally that will trigger a fairly short but possibly brutal
selloff in Precious Metals markets, and if another deflationary scare should
occur at some point despite the QE largesse, any such rally could be
amplified by a Pavlovian flight into US debt and
thus into the dollar. Let’s now review this evidence.
Our 3-year chart for the dollar index shows that
there is now a quite high degree of “compression” – it has
dropped a considerable distance below a still flat 200-day moving average to
become oversold. The tendency to proportion in markets points to a rally of
the kind projected on this chart, to complete the Right Shoulder of a large
Head-and-Shoulders top. Why, fundamentally, might it do this? –
here’s one very good reason; right now sentiment towards the dollar is
awful, it is at negative extremes with only about 7% confident of a dollar
rally. That kind of extreme just by itself is enough to generate a rally, if
only because there’s virtually no-one left to turn bearish. Another
good reason is that upon the Fed’s QE announcement the dollar was
broadly written off as “toast”, with those doing the writing off
temporarily forgetting that many other countries have plenty of reasons of
their own to debase their currencies, not least Europe, which pipped the Fed at the post when the German court members,
dressed in fancy red finery, and perhaps feeling the nozzle of a gun at their
backs, cleared the way the day before the Fed’s revelations for massive
European QE. So as the various fiat currencies jockey for position in the
race to the bottom, the heat could come off the dollar for a while, with the
worst news regarding it now in the public domain.
 
Bearing all the above in mind we will look now at the latest 6-month dollar
index chart where the dollar apparently broke down from a bear Flag on Thursday,
a development that on the face of it portends another steep drop similar in
magnitude to the one preceding the Flag. There are several reasons why this
scenario is unlikely, however. The first is that dollar sentiment is already
abysmally low, as mentioned above – at levels that are indicative of a
bottom. The second is that the Commercials now have massive short positions
in gold and immense short positions in silver, which means that there is a
high probability that they are about to plunge, and that is hardly likely to
happen with the dollar dropping hard. Still another reason is that the dollar
is close to strong support visible on its 3-year chart – the neckline
of the potential Head-and-Shoulders top. All of this suggests that the bear
Flag that has formed in the dollar over the past several weeks is a
“False Flag”, to borrow a term in use by conspiracy theorists,
and if it is, the dollar could suddenly take off strongly higher, breaking
out of the downtrend shown on the 6-month chart, which sentiment readings
certainly indicate is on the cards. Needless to say, a dollar upside breakout
here would be a nasty shock to many committed dollar bears and can be
expected to take the wind out of gold and silver’s sails, leaving them
vulnerable to a wave of heavy profit taking.
The following COT chart for the Euro FX reveals that the Commercials were heavily
long the euro before its whacking great recovery rally of recent months, when
of course the media were full of doom and gloom, but now their enthusiasm for
the euro has vanished, which means that they have transferred it to the
dollar.
Turning now at last to gold itself, its 6-month chart shows how it has
stalled out at a resistance level in recent weeks with the uptrend looking
like it has morphed into a bearish Rising Wedge, and with the pattern rapidly
closing up, breakdown may be imminent. It is recognized that the sideways
movement of the past couple of weeks has allowed the short-term overbought
condition to partially unwind, and that this has theoretically restored
upside potential, but for various reasons, including the convergence of the
channel just mentioned, breakdown is instead looking imminent. The
candlesticks with long upper shadows that have appeared over the past couple
of weeks are bearish in purport, and are another indication of impending
breakdown.
The 3-year gold chart shows the origins of the resistance that has capped its
advance in recent weeks. It can be traced back to the significant reversals
that occurred in November of 2011 and late in February this year at about
this level. Overall, however, gold does not look bad at all on its 3-year
chart, and while it does look set to be subjected to a possibly severe
correction in coming weeks, perhaps stretching out to a month or two, it
should then turn up again to continue with a major long-term uptrend as the
unseemly fiat race to the bottom intensifies.
The latest gold COT chart shows how Commercial short and Large and Small Spec
long positions have swelled to a high level that makes a reversal and
significant correction very probable over the short to medium-term. These
levels substantially exceed those reached late last February, prior to the
severe downtrend that followed.
To conclude, gold looks set up for a possibly sharp
drop soon. More sophisticated traders who examine the 6-month chart for gold
presented here will clock the massively advantageous risk/reward ratio for
gold shorts at this point, since any newly opened short positions can be
protected with an overhead closing stop that strictly limits losses if gold
breaks higher, placed just above the top line of the Rising Wedge.
On the site we will be looking at ways to capitalize
on the expected drop.
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