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Gold Breakout Coming

The clock is ticking on the gold breakout. Gold stocks have been in a tight consolidation range now for over two full weeks. The bollinger bands are growing narrower and narrower by the hour and this situation simply will not go on much longer. When volatility contracts like this it is always a prelude to a large move.

But how can I say that with such certainty? It's simple.

When volatility shrinks the selling and buying pressure becomes more and more equal. Imagine pressing two sides of a book with your hands as hard as you can. If you let the pressure off of one side of the book it will fly out of your hands in that direction.

This is exactly what happens in the stock market. Low volatility looks like inactivity. But it isn't. It is a fierce battle between longs and shorts which ends with one side giving up control of the market to the other side.

There are two important signs that tell me that this consolidation phase is going to soon end with a massive upside breakout.

First - the smart money is going long and the dumb money is getting shaken out. According to the latest Commitment of Traders report commercial traders actually went long 15,215 contracts last week and covered 5,245 contracts. At the same time non-commercial speculators (read hedge funds) liquidated 26,255 contracts.

This is important because it was a frenzy of momentum chasing hedge fund panic buying that created the September top in gold. Too many people got into the gold market and the supply of buyers got exhausted. That is what led to the dip we've seen over the past six weeks. Dips like this end when the dumb money gets shaken out and the smart money buys. The commitment of traders report is telling us that this is exactly what is happening now.

What we have seen is a classic bull market correction. They are sharp, fierce, and they scare people. They say bull markets climb a wall of worry and you can certainly see it in the gold market now. Go to any of the leading gold websites and it won't take you long to find an article from a gold newsletter writer predicting a big correction like the one we saw after last November.

I've gotten at least a half a dozen emails a day over the past week from people worried about the gold bull market. For instance people are worried that the dollar going up is going to make gold crash. The thing is the dollar has been going up since May and so has gold. That shouldn't be a concern right now.

Someone else pointed out that Warren Buffett announced that he is covering some of his dollar short positions for a loss. But so what? He should have bought gold. He is one of the world's largest owners of silver, so I guess that is close enough.

Right now I am fully invested in gold stocks. The truth of the matter is that nothing is happening with gold stocks or the gold market to make me think about selling any of my positions. People are just becoming impatient with gold during this consolidation phase. It hasn't dropped. It hasn't gone up. But the fact that it hasn't gone up big yet has people scared. Don't watch your investments so closely. You don't need to watch the minute by minute ticks go by.

Just evaluate things after the close everyday. Take a look at yesterday's close. Notice how tight the bollinger bands are and how the XAU is just points away from closing above its downtrend resistance line.

The chart tells a simple story. The XAU has support on its lower trend line and resistance on its upper trend line. When it breaks through one of these trend lines it is going to make its next big move.

That's all you need to know. You don't need to figure out every tick of the gold market or interpret every news item. Gold stocks will tell you what they are going to do when they move out of this triangle. Just listen.

I think it is going to breakout for the reasons I just stated. If that doesn't happen and we break down then I'll revaluate. You have to always have a back up plan, but this isn't the time to worry. Every day that gold stocks consolidate means that the frenzy that inevitably comes on a breakout will be even greater.

To find out what gold stocks Mike Swanson holds and plans on buying subscribe to his free Weekly Gold Report at http://wallstreetwindow.com/weeklygold.htm.

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