The following is commentary that originally appeared at Treasure Chests for the benefit of subscribers on Tuesday, October 19th, 2010.

Gold is overbought from a conventional technical perspective; of this there is little doubt. So the question then arises, if this is to be so, as fundamentals for rising gold and silver prices become stronger by the day (see below), what will cause the prices of precious metals to rise further from here, or after a mild correction? Answer: A widespread (think currency wars) and accelerated currency debasement. And simply to catch up to previous inflation, never mind what is coming. This is of course the right answer, however it's not what will motivate people to actually buy gold and silver. No, that distinction will go to rising prices, which are on the way, coming soon to a theatre near you - literally. (I'm not sure how much higher movie ticket prices can go without affecting demand, but rest assured prices will keep rising until this is discovered.)

But never mind movie ticket prices, as this is discretionary spending, which will suffer as prices continue to rise. How about food and energy prices? You know, those things we need to live and that consume large chunks of our incomes, but are considered unimportant in government inflation statistics. These are the things that people will finally start to notice when prices rise sufficiently that the lifestyles of increasing middle class people are affected. This, is when the lights will come on for growing numbers, which will cause them to finally look at precious metals seriously and buy. Right now the public is selling gold because they think the price is high and wish to pay bills. These people will be shocked at their lack of vision in the not too distant future when they realize they should have been buyers and not sellers.

This, and rising prices, will wake the public up to precious metals increasingly as time marches on, one by one, until the numbers are sufficient to wipe out what meager physical supplies are left. And then, as per above, and no matter what paper market games continue to be perpetuated by the bureaucracy's price managers, prices will rise on an accelerating basis. And it will need to accelerate, because the economy is so hollowed out now (because of mal-investment brought about by excessive easy money policies), the only way the Fed's 'price stability mandate' can be maintained is via accelerating inflation, or the system would likely collapse. This is important to understand of course because now the economy and need for stimulus are spiraling out of control, which again, guarantees the Fed's propensity to print money moving forward.

What's more, it should also be understood it's so bad, that in fact some further degree of hyperinflation may be experienced, as the bureaucracy will not go down voluntarily. Right now the US strategy is to simply devalue the dollar ($) to some degree thinking eventually natural forces will turn the economy around. What they fail to realize however is we are dealing with Super-cycle Degree forces this time around, like demographics and a topped credit cycle, that simply will not allow for such an easy outcome. And when you throw the deflationary implications of Peak Oil into the formula, where less oil will lead to less people, which in turn will lead to less money required, the idiocy of present policy becomes clear.

Be that as it may, boys will be boys however, and humans will be humans, so in attempting to thwart this eventuality we are tackling Mother Nature head on with monetary inflation, hoping the economy will magically turn around, instead of conserving and planning sustainable living economies. So again, this is why some degree of hyperinflation may be experienced in the larger / global economy, however between the factors discussed above and bond markets it should be understood it will never get like Zimbabwe, nowhere near this level. Still however, it's getting bad enough. It's getting bad enough one must protect their families from the effects of both inflation now, and deflation later, where it should be understood precious metals fills both of these roles.

And this is a large part of the reason gold has been performing so well in spite of continued official intervention, because of educated demand fearful of government misdoing set against dwindling physical availability. Of course there is also speculator / hedger betting practices in the paper markets that will also continue to be a factor, however this will likely have less importance moving forward if physical demand continues to outstrip supplies. Increasing official sector buying should accomplish this eventually, however as you can see below with gold at the top of its expanded channel, and as per our opening remarks, gold is overbought and likely in need of a correction. (See Figure 1)

Figure 1

Further to the above, this why precious metals shares are attempting to break out as well, this, and now reversed gambler practices in the betting parlors. That is to say while inflation, physical off-take, and increasing scarcity are undoubtedly significant ongoing and maturing factors in precious metals pricing moving forward, because a growing consensus of options players have been betting / hedging long precious metal share positions, which has had the effect of sending open interest put / call ratios on both precious metal share indexes and individual shares higher, sentiment / structure wise, in order for precious metals shares to be in a position to rally on a sustainable basis they must climb a wall of worry, which is what they have been doing throughout the past few months. And in turn, this will embolden, scare, etc. people into buying more physical, and supplies will continue to tighten in a re-enforcing loop.

Along these lines then, the Amex Gold Bugs Index (HUI) finished last week above triple top resistance at 520 (just barely), however based on a post expiry crash in open interest put / call ratios across the sector, if this does not change soon (and it probably won't), this breakout will most likely fail. At present we are in a five-week options cycle that extends into November, which means options profiles can basically have no effect on the trade this week, and little next week, however if the open interest put / call ratio profiles for the sector do not improve by the new month for sure, and maybe before (who really knows when), then intermediate degree reversals across the sector will most likely be triggered. The HUI finished yesterday just above triple top breakout resistance at 520, but is poised to break lower based on sentiment measures, so be careful with trading positions even though at present we are only expecting a routine pullback in the sector, which is in line with seasonal tendencies. (See Figure 2)

Figure 2

Of course we could be wrong about the extent of this anticipated correction if the broads are sucked into a seasonal inversion, which is quite possible based on collapses in their open interest put / call ratios as well. Here, and although we will not display updated charts today because of possible post expiry adjustments that sometimes don't show up for a few days, like precious metals, if things don't change between now and next week, five-week cycle or not, things could get ugly in a hurry, especially considering risk is now heavily overbought for both the metals (think CDNX) and the broads (think NASDAQ 100 / Dow Ratio). Again, we are not expecting this, however if put / call ratios don't bounce back significantly, it should be understood anything can happen.

In this respect, the significance of the juncture we are at is reflected in the monthly NASDAQ / Dow Ratio plot seen here last week, where values have now run right up to bubble territory resistance at present, meaning the only way equities go higher is if US stocks re-enter a mania in tech stocks. And the only way this is going to happen is if the $ keeps falling, where it's on critical support, but likely temporary support as per our analysis last week. With the public pulling their money out of stocks, the bank - you name it - en mass no matter how much money is printed however, and especially if speculator sentiment is not predisposed (bearish), which is definitely not the case, it's hard envision equities rising right now, which should support the $ temporarily.

This can of course change, which is what we expect, but not before a consolidation of gains across the equity complex traces out. In this regard, look for the recent RSI breakout in the Philadelphia Gold and Silver Index (XAU) to be tested at approximately 60. We do not want to see it slip back into or below diamond support however, as this would signal a potentially profound loss of momentum that could send the MACD and oscillators down. Such an outcome would not be desirable at this point as it would make it more difficult to regain lost momentum running into year end and next year, not that Bernanke actually following through with some degree of QE2 on November 3rd would make this impossible. (See Figure 3)

Figure 3

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Good investing all.