Our last public update called for a two week rally in the Aussie dollar and gold. We have since covered those positions and are again looking to buy US dollars after the sharp February retracment. This update will concentrate on why we remain bearish on gold and bullish on the dollar for 2005. But we will not rehash old ideas. Instead we will introduce to you our newly devised "Gold Directional Indicator," or GDI, which we've been told may appear in a Barrons article on gold next week.

Recall that we said three weeks ago to expect an intermediate term low in gold and silver stocks. Below is the original weekly chart of XAU and the update. This week we might see one last push to 100/105 before a reversal to target 75/80 over the coming months, but the current advance can count complete as it is.

If our forecast for an "ABC" type decline is correct then we should expect a rally in the dollar and decline in equity markets over the coming months, lasting until the end of August.

To gain additional insight into the gold market, and thus the relative direction of implied liquidity in the system we show a chart of the XAU to gold ratio and gold priced in euros. Some gold analysts like to use the XAU to gold ratio as a leading indicator of gold priced in dollars, but actually this ratio has a more precise relationship with gold priced in euros. That the link is stronger than with the dollar price of gold makes sense because gold is produced all over the world and profits realized in many different currencies, giving a truer sense of the expectations investors hold for gold.

As you can see, gold priced in euros is testing very strong resistance at the 50% retracement. So too is the XAU to gold ratio, implying that gold may face formidable resistance. Therefore, while we do think gold may rally to $440 in the coming days, this Fibonacci resistance level (61.8%) should repel the advance.

The reason we feel so strongly that gold reached a major top three months ago is not just because of our parallel view that the dollar has bottomed. Note how in the previous chart we showed that both the XAU to gold ratio and gold priced in euros have a highly positive correlation - more so than with the dollar price of gold. As such, we have devised an index to price them both as one. We call it the "Gold Directional Indicator," or GDI. Below we show a two-year chart of gold and our GDI.

Note that the April 2004 peak of $433 was not confirmed by the GDI. More importantly, the November 2004 high of $455 did not see new highs either. The implication of course is that the most recent peak at $455 is a major top, not intermediate like the April 2004 high.

That means the current rebound is most likely a correction. Therefore, the retracement of the 2001 to 2004 rally should last more than just two months and most likely carry prices back to $375 in August where we will become rabid gold bugs again.

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