Originally published January 18th, 2009.

The 3 main predictions made over the past several weeks have come to pass - bonds have topped out and come close to completing a Head-and-Shoulders reversal, the dollar index has rallied further to our target in the 84 - 85 area and gold and silver have reacted, with silver reacting mildly compared to gold, also as predicted. The question now of course, particularly after the strong gains on Friday, is whether the reaction in the Precious Metals sector has run its course. Before attempting to answer this question it is worth stepping back to make some general observations about gold and the grave financial crisis gripping the world.

The first obvious point to make is that since business leaders and politicians are attempting to address the crisis by employing the exact same methods, in extremis, that got us into the mess in the first place - not to solve the crisis because it is beyond solving by traditional methods, but to procrastinate - then the situation is only going to get worse with time. They have bought time by creating additional money in vast unimaginable quantities and using it as a life support system for numerous major companies and institutions that would otherwise be declared bankrupt, with the result that these failed entities continue to stumble forward as undead zombies whose consuming objective is to sink their fangs into the taxpayer and bleed him white. The latest addition to the ranks of these still active corpses is Bank of America. The other main plank of their coordinated response to the crisis is to reduce interest rates to zero in a desperate attempt to mitigate the effects of extreme indebtedness and stoke up some economic activity, neither of which are working as debts are now at such astronomic levels that even near zero interest rates make little difference, and cheap money will not be taken up in an environment where demand has collapsed - they are pushing on a piece of string with this one. What they have succeeded in doing with their bailouts and throwing money around is to balloon the money supply in leaps and bounds and these vast increases in liquidity are working their way through the system to emerge later this year as hyperinflation. These increases also undermining the dollar, of course, and even though other countries are scrambling to debase their currencies as fast as they can to maintain their competitive edge, they can't hope to keep up with the US or Zimbabwe. Situations of extreme crisis and especially hyperinflationary conditions are very bullish for gold.

Thus, even though the larger downtrend from the high last March remains in force, as we can see on the 1-year chart for gold, we should be able to see evidence that the major forces at work in the background are swinging the trend slowly from down to up, and we can. Gold's last rally in November and December took it substantially above its 50-day moving average, with the result that this indicator has turned up - the first tentative sign of a major change of trend. The next important positive technical development will be the current reaction stopping at or above the September and early December lows. Should it do so it will confirm the technical pattern from last August - September as a probable large Head-and-Shoulders bottom - a formation which is also visible on the gold stock index charts and the charts of many individual large gold stocks such as Barrick and Goldcorp.

Now to attempt to answer the question of whether the reaction in gold has now run its course, as is suggested by the strong bounce off the 50-day moving average by both gold and silver last Friday. Readers of the last update may recall that we had been looking for the dollar to rally up to 84 on its index, maximum 85, and then go into reverse, and for gold to react to the $800 area on such a dollar rally, and that is what has happened, as we can see on both the gold chart and the 6-month dollar chart. So it does look like gold's reaction is complete and a new uptrend is starting which will sychronize with renewed dollar weakness, although the really big action will only get started when it breaks above the red downtrend lines shown on the chart. On the 6-month chart we can see that a larger potential Head-and-Shoulders top of higher order can be delineated and if this is correct then it calls for a really heavy decline once the "neckline" of the pattern now in the 79.50 area is broken. The one thing giving rise to some doubt is that it would be preferable, technically speaking, for gold to mark out a more symmetrical Head-and-Shoulders bottom by dropping down to make a Right Shoulder low nearer to the Left Shoulder low last September at about $750. In a situation where the Fed and others work the levers to engineer a dollar rally above the resistance shown in the 84 - 85 area, it would then likely run quickly to the next resistance approaching 88, which would be the occasion for gold to drop back to the $750 area. Although considered less likely, this is a scenario that we should be remain aware of.

The bond market charts look particularly ominous with a clear Head-and-Shoulders top appearing to be approaching completion, as can be seen on the accompanying 6-month chart for the US 10-year Treasury Note. While the pattern could yet abort before completion, a breakdown below the neckline can be expected to trigger a plunge. Given that the bond market is about 10 times greater than the stockmarket it is clear that such a development will ratchet up an already severe crisis by a whole order of magnitude.

Below is the bond market prediction included in the Gold Market update of 22nd December last.