Originally published October 28th, 2012.

The top in gold was called within a day of its actual occurrence in the last update several weeks back, since which time it has been in steady retreat. This retreat has not been as steep as we had expected, but then, the dollar has not even started a new uptrend - yet.

We can see how gold has reacted back from its intermediate top in a nice orderly downtrend on its 6-month chart below. We had correctly identified the bearish Rising Wedge whilst the price was very near the high and before it broke down, enabling us to short the sector at the optimum moment, and even though it has not dropped as steeply as we anticipated, we have still done alright, an outstanding performer in our basket being our GLD Nov 171 Puts which have almost quintupled. This is in marked contrast to the sheep following their cheerleaders, who have been fleeced, yet again. We also shorted the oil sector just ahead of the latest vicious plunge, to good effect.

As Ed Bugos now of Goldenbar once unforgettably said to me "You are only as good as your last call in this business", so there's little time for gloating, especially as we have not closed out our shorts yet, and our challenge now is to attempt to determine whether this downtrend has further to run, or whether we have just seen a correction that has about run its course. To do this we need to weigh up various factors.

Let's start by reviewing recent action in detail on gold's 6-month chart. Gold has behaved well technically, breaking down from the uptrend that had taken it to an overbought extreme, after a neat bearish Rising Wedge had completed. The subsequent downtrend has been steady and orderly and has taken the price back down through its quite strongly rising 50-day moving average, in the process completely unwinding the overbought condition that had earlier existed, and it now heading down towards its 200-day moving average and a zone of quite strong support beneath this average in the $1620 area.

Quite obviously, the lower gold goes, the more oversold it gets and the greater are the chances of its turning up again. How far down will it go before this decline stops? - we are going to use the latest COT charts to assess the positions of Smart Money, as we did before, to help us to determine this a little later, but first we will see how the correct delineation of the current downtrend channel enables us to implement an effective trading strategy that will allow us to maximize profit potential whilst at the same time getting us out of harm's way in the event that gold suddenly reverses to the upside.

First of all, if you are not short already, it's probably best to forget it at this point. Gold is now starting to get oversold, increasing the chances of a rally. We entered our short positions at the optimum time, when the risk/reward ratio was highly favorable as we had close overhead stops and it has worked out nicely, and we can afford to run them to milk the downtrend for all it's worth. We stay short and we exit all gold and gold ETF and Put options positions immediately if gold should make a clear closing break above the downtrend, clear meaning $5 or more above it. Do we reverse to long if we see such a breakout? - probably not, because the COTs are still overall bearish, as we will see later, so what could happen is that we see a possibly false breakout by gold as the dollar backs off temporarily from the resistance it is now challenging, followed by a plunge as the dollar turns higher again and breaks out.

The 3-year chart for gold is interesting as it reveals that it should be considered rangebound with an overall neutral trend whilst it remains between the nearest zones of support and resistance shown on the chart. Failure of the major support level shown would be a very bearish development that would be associated with a deflationary downside, which the current COT structure makes clear is very possible despite the Fed's desperate money pumping and the rabid bullishness of cheerleaders. The next major upleg would be signaled by a clear break above the highs in the $1900 area.

The latest COT chart for gold shows that whilst the extreme readings of a few weeks back have eased as the price has dropped back over the past several weeks, Commercial short and Large Spec long positions are still at a historically high level - close to the level they were at last March ahead of a multi-month retreat by the PM sector that resulted in savage losses in PM stocks. So there is certainly plenty of scope, just going on the COTs, for the current downtrend in gold to carry it a lot lower before it's done.

The outlook for the dollar has of course a crucial bearing on the future prices of commodities in general, and gold and silver in particular. Since the Fed's announcement of QE3, and that it would be open ended, the dollar has been widely written off as "toast", and obituaries for it have been everywhere, and sentiment towards it has been awful. Meanwhile, however, the Commercials have gone heavily long. This is the stuff of market bottoms, and it is why we were looking for the dollar to break out of its downtrend in the last update, which it did just last week. So how does it looks now?

On the 6-month chart for the dollar index below we can see how the "false Flag" in the dollar that formed during the latter part of September aborted, just as we expected, and after some zig-zagging around, also expected, which involved a successful test of support towards the recent lows, the dollar broke out of its downtrend last week, and then moved to challenge the resistance at the top of its potential base area, breakout of above which will mark the start of a new uptrend, which will be bad news indeed for the Precious Metals.

While the dollar may back off briefly here, especially as it is being pressured now by its falling 50-day moving average, it still looks like it is shaping up to break out soon from the suspected base area to enter an uptrend, a view that is supported by the latest COT charts which show the seldom wrong Commercials to be heavily long the dollar.

If the dollar does break out soon, how far will it get? The 3-year chart for the dollar index assists us in answering this question. On this chart the laws of proportion in markets suggest that it is likely to rally up to the vicinity of its January highs to mark out the Right Shoulder of a potential Head-and-Shoulders top. If this is what it does we are looking at a target for the advance at about 81.70 - such a move would result in substantial further losses for gold and silver and would probably result in them dropping down to the target support zones shown on their respective 6-month charts. If a deflationary downwave ensues, which does not look out of the question given the current COT structure, the dollar could go much higher as a result of a Pavlovian flight into Treasuries.

The latest COTs reveal that the Commercials have a high long position in the dollar and a comparatively very low long position in the euro (down from much higher levels earlier). This is a strong indication that a dollar rally is brewing.

Public Opinion on the dollar, which had dropped back heavily to comparatively low levels, is just starting to improve, as it should, considering that the dollar has now broken out of its downtrend and is starting to look like it is coming to life again.