Originally published February 7th, 2010.

Gold performed as predicted in the last update, rallying up to the top of its Descending Triangle before reversing and crashing support at the bottom of the Triangle on Thursday. Many traders were startled by the magnitude of Thursday's $45 drop. It was a bearish development for reasons we will come to shortly, but paradoxically it was immediately followed by a "Reversal Day" on Friday, which is a sign that the steep drop has exhausted itself - for now. Bulls, who were poleaxed by Thursday's plunge, are already dancing on the rooftops proclaiming that the "correction" is over as a result of the recovery late on Friday. So what are we to make of this seemingly contradictory market action? Let's see what the chart is saying.

On the 2-year plus chart for gold we can see the rally up to the top of the Triangle early last week and how it was quickly followed by reversal and a plunge which crashed the support at the bottom of the Triangle. This plunge is given added significance due to the fact that it resulted in gold breaking down from the major channel shown - this is why the drop was so large. We have not employed this channel before but it is thought to have great importance as it relates closely to a similar parallel channel for silver drawn from the same point of origin in time on arithmetic scale. As we can see, gold's breakdown from this channel is thus far not by a sufficient margin to be convincing, but the same cannot be said of silver (see Silver Market update). On the silver chart we have a clear breakdown that is thought to mark the start of a phase of severe decline, which implies that the breakdown on the gold chart, although still marginal, is genuine.

So, gold and silver break down from uptrends, but then the next day bullish hammers (in the case of gold it was more a "dragonfly doji") appear on their charts indicating reversal. What can this mean? The reasons for the late rebound are not hard to find. Gold has dropped back steeply towards a zone of strong support just above the giant 20-month trading range and near its rising 200-day moving average, and is now oversold, factors which alone would normally move us to buy, as it would be unlikely to break down through this support without at least a token rally - and Friday's rebound is thought to signal the start of it. Token is all it is likely to be, however, because the macro environment is fast deteriorating. As already mentioned the silver chart looks terrible. Copper has broken down to enter a bearmarket that promises to be brutal given its high stock levels, although its COT chart improved dramatically last week so a relief rally is very possible.The stockmarket, whose big bearmarket rally is believed to have run its course and whose technicals have been deteriorating for weeks or even months, is rolling over into a decline that looks likely to be severe - probably on a par with 2008. The gold stock indices have broken down decisively from their year-long uptrends, although they are due a brief relief rally, and of course the dollar is in a vigorous uptrend, even if it does react back short-term.

If, after a brief relief rally, gold does go on to break down below the strong support and drop away steeply, does it mean that its long bullmarket is over as another deflationary downwave strikes? Probably not - because politicians will panic like they did last time and open the floodgates to an even bigger tsunami of liquidity creation and bailouts, which next time lead can be expected to lead to massive inflation/hyperinflation as the situation spirals out of control. Once they open the spigots again gold and silver will truly soar into a spectacular parabolic blowoff, but in the meantime it looks like we are going to have to deal with Deflationary Downwave Mk 2, which might also be named "Son of Crash 2008".

In conclusion, a short-lived rally looks likely in gold and silver lasting perhaps a week or two, several weeks at most, after which they are expected to turn and plunge again. This rally is likely to be weak and unable to surpass the $1100 level. Should gold succeed in breaking above the top line of the Triangle, now at about $1110, it would turn the picture more bullish and would be expected to ignite a more powerful rally.