Originally published March 21st, 2010

The dollar succeeded in confounding many experts late last week with a sudden strong rally. Fred Starkey earlier described it as marking out a Head-and-Shoulders top, which it appears to have aborted, "Fractal Dave" was caught out by the big drop in gold on Friday caused by the dollar strength, when he had expected it to rise. Peter Schiff recently set out the fundamental case why the dollar should plunge - which has not been invalidated, but in this business timing is everything. Only the wavers, who have been steadfastly bearish, ended the week looking good at last. We are well aware of their arguments, and have not gone along with them thus far, because there was money to be made. In practical terms being right too soon is as bad as being wrong.

A reason we couldn't get egg on our faces was that we freely admitted that we didn't know which way it would break - and it still isn't quite conclusive, - in the article THE DOLLAR - another upleg, or GAME OVER?? and have remained perched on the fence, but with an awareness of what a break either way would probably lead to.

The inflation - deflation arguments still rage as they have since the deflationary maelstrom of 2008, which was beaten back by a massively inflationary counterattack, but the problem is that deflationary forces have built up such a head of steam after the antics of Clinton, then Greenspan and now Bernanke and co and of course Wall St generally that they are nigh on unstoppable. The key point to grasp is that this is not a black and white situation - it is not that we will have either inflation or deflation, for both these forces are in play at the same time. What will determine the fortunes of investments will be which of these two forces predominates. In the recent past this has been very difficult to calculate, which explains the confusing crosscurrents in commodity and stockmarkets. This is the reason why at times it is not unreasonable to sit on the fence and wait for the market to tip its hand, or if taking positions to do so at good entry points with close stops. Looking at the dollar index chart it could be claimed that the market already tipped its hand several months ago, when the current robust rally started, but remember that much of this rally thus far can be attributed to the Euro crisis, not to deflation fears.

We will now look at the gold chart to see how it has been faring in the recent past and to figure what its current pattern implies going forward. Gold had been doing well - it had broken out of a bullish Falling Wedge pattern in February, successfully tested support at the top of the pattern, and then appeared to be consolidating ahead of another advance, which of course presupposed that the dollar would either reverse at best or at worst go into a sideways pattern. Now we have to review gold's pattern in the light of the dollar's renewed strength late last week which suggests that another strong upleg may be imminent. The failure of gold to follow through on its February breakout is certainly increasing the risk that its hitherto bullish pattern will abort, especially as the sharp drop on Friday has resulted in the completion of what now looks like a small Head-and-Shoulders top above neckline support at about $1100. While failure of this support would be expected to lead to the price dropping back at least to the red "danger zone" support, a failure of this latter support at the apex of the Falling Wedge would be a much more serious matter as it would signify that the earlier breakout back last October from the 20-month consolidation pattern was false. Such a development would open the door to a deflationary plunge - and not just in gold. Note, however, that gold has not broken down as yet from this potential Head-and-Shoulders top just as the dollar has not quite broken out yet to commence another strong upleg, although these developments are now looking increasingly probable - but until they happen there is still the chance that gold will rally and the dollar drop away.

Many thought that the dollar was breaking down by the middle of last week, but as we can see on our 6-month dollar index chart, the break of the channel support line was only marginal and the support at the mid-March lows and just above the rising 50-day moving average held. Then it took off strongly higher on Thursday and Friday in what looks like the start of another upleg, although we can be more certain that it is once it breaks above the resistance shown. Two factors supporting another upleg here are that most shorter-term oscillators are close to neutrality or only moderately overbought after the sideways trading of the past 6 weeks, and moving averages are in bullish alignment with the 200-day moving average now turning up. While it is clear that that the dollar rally up until now has been fuelled largely by euro weakness, deflationary factors may play an increasing part in a continuation of the rally.

If we compare the charts for gold and the dollar we readily see that the last 2 dollar uplegs in December and January into February hit gold quite hard, and if we now see a third dollar upleg it should be obvious that it will get hit again.

There are other circumstantial factors across the markets that do not bode well for gold at this time. One is the blatant non-confirmation of gold's breakout to new highs both by silver and the main gold stock indices. Another is the heavy Commercial short position in oil suggesting a big drop looming. Still another is the Double Top that appears to be forming in copper and finally the broad stockmarket is now critically overbought.

Would a severe decline by the Precious Metals at this point mean that the bullmarket in gold and silver is over? - probably not - because those in power can be expected to respond to the resurgence of deflation the same way they did last time - with bailouts, money printing and the suppression of interest rates - but this time they will have to do these things on an even grander scale that will pave the way for hyperinflation - so we are likely to see another roller coaster ride with an "icicle" bottom, and we will be ready and waiting to pounce if prices plunge again as they did in 2008.