The excerpt below is taken from a newsletter produced by The GoldenBar Report for private clients: http://www.goldenbar.com/.

22-Sep-06: "...if inflation has already lasted for some time, a great many activities will have become dependent on its continuance at a progressive rate, we will have a situation in which, in spite of rising prices, many firms will be making losses, and there may be substantial unemployment. Depression with rising prices is a typical consequence of a mere braking of the increase in the rate of inflation once the economy has been geared to a certain rate of inflation" - from an essay titled, "Can We Still Avoid Inflation", given by Friedrich Hayek in a 1970 "given as a lecture before the Trustees and guests of the Foundation for Economic Education at Tarrytown..."

See the full essay published here: http://www.mises.org/tradcycl/avoidinf.asp
Full exposition of the Austrian Trade Cycle Theory here: http://www.mises.org/tradcycl.asp

Hayek is talking about the boom-bust cycle which is fundamental to my general outlook. I am simplifying for the moment, but at the late stages of the typical credit induced boom, or earlier if the rate of growth in money and credit is slowed deliberately, profit margins tend to shrink as factor prices (costs) outpace selling prices, as we have seen in some sectors of the US economy. Thus, the "mere breaking of the increase in the rate of inflation" - relative to what is already expected - will reveal the unsustainable nature of the boom in precisely this way.

Based on the Austrian trade-cycle theory the US economic boom should be coming apart right about now, as US money supply growth rates have slowed to their lowest levels in ten years. Although there are signs of the symptoms surfacing in various sectors (housing, carmakers, and the airlines are the best known instances), the averages have continued to roar ahead: led by the telecoms, healthcare, REIT's, brokers and carmakers; while sectors that have been bullish stalwarts up until a few months ago (energies, commodity-related, gold's, steels, builders and the transportation issues) have weighed.

The reason for the advance, in our view however, is not so much related to the prospects for renewed economic growth, as you can surmise from the trend in earnings growth in the chart on the right, but rather two distractions: the unwinding of too much pessimism; and the effects of an oil price decline on inflation expectations and the outlook for cost pressures.

Of course, when oil prices are rising and the bears point to that as a bearish fact for stock valuations, the bulls are quick to respond that labor makes up the bulk of production costs.

According to the US Bureau of Labor's (BLS) data, the trend in hourly wages paid in US currency turned sharply upward back in 2004, and without taking into account the increasing costs of providing benefits (monetary and non-monetary), they are growing at their fastest year over year pace (+3.9%) in over five years now. According to the Austrian trade-cycle theory, we should be nearing the point of inflection where the combination of rising costs and lesser "stimulation" produce greater margin erosion, which may also explain the slowing trend of earnings growth. In order to head this dreadful situation off, the central bank would need to re-inflate, or risk exposing the boom, and watch it turn to bust - which as Hayek described is typically accompanied by both rising unemployment and prices (post 1934).

So: rising factor prices, and falling profit margins and profit growth are expected symptoms of the process of the monetary policy that removes accommodation from one of the longest credit-induced booms in recent history.

But, there is no big trouble in the labor market yet and hence one of the important questions that we are trying to answer in this report is that if the relatively minor reduction in monetary accommodation in 1999 was enough to take down the tech bubble why hasn't the current near-neutral US monetary policy yet resulted in a similar bust?

The answer could have significant implications for the intermediate gold price outlook in light of what we know of the historical relationship between gold prices and the stock market cycle. If the answer that we have come up with is satisfactory then the current advance in stock prices is the final thrust upward before stumbling over itself; but if it is incorrect - i.e. cost pressures ease enough to send stock prices on a 1996-1999 style advance - then our allocation (long gold / short financials) is wrong. But the current environment simply looks nothing like what occurred then. It looks more like what Hayek and the Austrian School describe for the late stages of the trade cycle, except perhaps more gradual than we tend to expect. Should the central bank re-inflate to head it off without waiting for an accident, it is possible that our 'shorts' will be wrong, but not necessarily, as markets have become inflation sensitive in recent years, may sense desperation in the move, and drive yields higher.

The Bugos Gold Price Outlook Downgraded:
- Conditionally Bullish on Intermediate Outlook
- Conditionally Bearish on Short Term Outlook
- Steadfastly Bullish on Long Term Outlook

I started out trying to poke holes in my bullish outlook, and succeeded. My bullish argument for the intermediate outlook is now full of holes, metaphorically. Some bearish facts have crept into the picture that either didn't exist previously or were simply out of focus, which suggest that the 6-year bull market sequence (or primary advance in technical jargon) in gold prices and gold stocks that began in 2001, despite my want, may have completed in May. Yet other signs point to a primary peak some time in December/January. My conviction is still with the latter but it is tentative and needs confirmation from chart developments in gold, USd, and stock market trends.

Meanwhile, it would be advisably prudent to be conservative on the long side right now (see conclusion).

My valuation thesis (based on money, commodity ratios and supply) suggests gold is still relatively undervalued, but that indication alone would have kept you long and wrong throughout the nineties. The gold sector charts appear to be working for the bears at the moment and bullish confidence may not yet be ingrained enough to buck the emerging bearish intermediate technical condition of the commodity complex, especially if combined with a bear market rally in the greenback - an increased possibility on both fundamental and technical grounds.

History provides us with at least three important action precedents that I will elaborate on today in a comparison with gold's 1962-80 bull market era. The first is that USd gold prices tend to peak six to ten months following a cyclical trough in the growth rate of the US money aggregate MZM (i.e. when it drops below 4% year over year) regardless of whether a new cycle has already kicked off by then; the second is that gold prices tend to peak following major stock price declines and only rarely beforehand; the final historical fact is that gold stocks are more likely to rally during a decline in the general stock market if they hadn't rallied too much ahead of time.

Aside from hoping to realize the fantasy one day that the markets will value gold fairly, I see only two potential sources of bullish catalysts for gold prices in the intermediate term: a stock market reversal and break out in war somewhere with someone - both of these things have been widely expected and those expectations are seeing some deflation right now, perhaps. Our original targets for the primary gold price sequence were met this year.

My upgraded targets (US$865 gold and 425 HUI) are less certain in light of US monetary trends, developments in the charts of commodities, currencies and gold stocks, as well as a drop off in inflation expectations generally.

Please note that my frame of reference is the intermediate and long term outlook; short term swings typically get little weight except to the extent that they complete or confirm a hypothesis about the longer term sequences.

In other words, the commodity markets may well bounce after my less than sanguine report.

Let me disclose that I tend to be a little early in my calls on changes in the primary sequence. However, I may have already accounted for this character flaw. Right now I am feeling as though the facts are nagging at me to make a bearish call but I am resisting because on some level I have become attached to the bullish case, not wishing to let go of the bullish outlook even if only for the medium term (usually 6-24 months). The bull market has confirmed and rewarded our decisions to buy the 15% corrections in gold and the 30% corrections in gold stocks for nearly six years now, and to step outside of such a comfortable Pavlovian box is difficult for a human.

But, we all know that traders aren't human! They cannot afford to fall in love, or to hate, like humans. Mr. Market, as Warren Buffett collectively identifies it, tends to change the rules just when everyone has become accustomed to them... when complacency reigns for instance. I sense some of that today, in myself as well.

Fortunately, my bullish argument is not entirely emotionally rooted - there are good objective premises too!

Basically, here is how events are making me see things into to the yearend and into next summer: gold prices have either already peaked in the primary sequence, or will by December/January, then either way will fall back 30-40 percent from their highs during the subsequent (post-peak) 12 months before resuming the long term bull market (we could go to US$900-1000 then drop to US$600, or we could drop to the mid US$400's if the peak is already in); gold shares have probably peaked - they might revisit their highs but less likely than gold - and the HUI is likely to fall back to the 200-250 level sometime in the next year before resuming its secular bull market; the commodity complex has likely peaked in the four year (primary) sequence and is either forming a top right now, or has already begun a liquidation of its first primary sequence (i.e. CRB could head back down to 250, oil prices could bottom in the low US$50's, and the price of copper could fall back to the low US$2/lbs handle); the US dollar index may rally back up to the 100 level before resuming a bear market (that's not a big rally and it is still at its long term lows right now); stock prices could continue to rally on some of these evolving trends until the Dow registers new all time highs then turn down for a substantial drop as the expected bust materializes.

This view is summarized again in the conclusion where it is related to our allocation and investment strategy, but below is an outline for the premises that yield my mixed and uncertain intermediate outlook for gold prices:

Bullish Facts for Gold Price, Intermediate Outlook (3-18 months)

• Historical gold price relationship to US stock market cycle (gold price trends peak after stocks bottom)
• Valuation (monetary, demand/supply, and relative to oil and copper, gold is cheap under US$900)
• Unknown geopolitical outcomes (implications more likely bullish than bearish; but bearish short term)
• Monetary policy, underlying bias (deflation-phobic)
• Economic outlook (pointing to the bust scenario or remedial inflation policy)

Bearish Facts for Gold Price, Intermediate Outlook (3-18 months)

• Monetary trends (gold historically peaks 6-10 months after MZM troughs, which it did in June 2005)
• Technicals (mature in primary sequence, bearish bias in intermediate sequence, climax in May?)
• General commodity and currency trends (charts hold increasingly bearish implications for gold)
• Deflating inflation expectations (could persist until commodities bottom or Fed steps on gas again)

The major assumption for the not so bullish conclusions in my report today is that US monetary trends will not drastically change until after the boom is revealed and a bust materializes in financial assets. At that point it is expected that the central bank would re-inflate money and credit. Should the Fed step in to slash interest rates tomorrow, hypothetically speaking, igniting a new monetary cycle to pre-empt or head off a bust before it occurs, the outlooks in our report would be scrapped and revisited, particularly for the currency and commodity complex.

Technical Analysis: CRB, Breadth Weighs

The bears broke a four year bullish sequence in the CRB this month, pushing it to new 14 month lows near 300 - currently about 17% off its May high - pressured by the energy commodities for the most part, but also, some of the softs have weighed, particularly sugar and cocoa prices which are off 20-30 percent from their summer highs. The index is highly oversold in the short term, and likely to bounce back up into the range delineated in the chart to the right between 315 and 330 before completing the move to < 300.

Many commodities, metals included, saw a peak in May amid somewhat of a general climax; but others, like Crude, and some of the agricultural commodities (not the main ones), peaked in July.

In fact, only the livestock markets were still making new highs by the time September rolled around. People are buying food. We can see that in the action of the food stocks too. Maybe it is a SafeHaven run, which the bond market may be confirming to some extent. But gold isn't. Neither is the general stock market trend, yet anyhow.

While the energy markets may also be a little oversold in the short term, and except for natural gas prices have not yet fallen through the last highest trend low in the four year sequence to confirm the CRB break down, the technical chalk marks for the four year sequence suggest that new highs are not likely in the medium term and that intermediate stage tops may be forming that could send Crude prices back down to the high US$40 range.

Apart from the natural gas market, and sugar, no other commodity has yet confirmed the recent CRB break down either - at least among those where trends existed. Most of the softs, and even some of the grains, may have peaked two to three years ago (even wheat prices have gyrated within a wide range). The metals are all holding their last highest trend lows, as well as the important moving averages, and have not made lower lows, though I sense material downside in base metal prices - which have been the object of a mini-mania this year.

Platinum and silver prices also worry me a little.

And finally, livestock markets have, like wheat, mostly just been gyrating within a three year range.

Perhaps it is possible that these two markets, like gold, haven't peaked yet and are about to have their turn; and in fact, I still like the wheat chart in particular. The market looks like it wants to break out of a five year range on the long term charts. In fact, the whole 10-yr chart looks like a saucer. But I don't understand the fundamentals of wheat; you have to tap into weather trends (maybe it is gearing up for a global climate change bubble!), and understand the politics of producing synthetic wheat, etc. So could we have a food and gold rally? I don't know.

Ask Jim Rogers. What I do know is that over the past year the CRB has advanced on narrowing breadth and increasingly concentrated mini-manias in the energy and metals markets, with gold mostly following suit but rarely stealing the spotlight... except briefly in April-May. I believe the technicals are currently confirming my monetary analysis and related valuation judgment. Even technically, the commodity average reached its primary technical objective (based on the parameters of the break out from a five year bottom in late 2002) as it blew through the 300 barrier last year, overshooting our most optimistic targets for the move early in 2006.

My short term outlook is for this average to find support above the 290 level, rally back up to about 340, plus or minus, then correct back to 260-280 on weak metal (ex-gold) and oil prices in the intermediate outlook.

Should the bulls recover the 360 handle, either it will be part of a topping formation or a consolidation - either way we are not looking for sustainable new highs to emerge until after a stock market correction, and after a new monetary cycle gets underway. My intermediate outlook is at best neutral. Potential support may come from gold if our outlook is right, or from oil prices if some holocaust like 'event' happens on the supply side.

Gold: Some Exhaustion in Primary Leg, Scope and Catalysts Remain for Bullish Case

In the post-spring period gold prices have held up better than the CRB generally, as well as energy prices, but have either matched or slipped against everything else, including equity prices and most currencies. Gold has not held up against the other metals, and has only matched copper and the precious metals platinum and silver.

It has not been the worst performing commodity over the past five years, but has underperformed the other metals and oil prices fairly consistently since 2003 (though gold shares outperformed most other equity sectors from 2001). Still, the April-May move seemed climactic, and occurred within a narrowing commodity advance, in the sixth year of a sequence that started in 2001; another bearish technical fact, in my opinion, is that many gold bulls believe that the move that started in late 2005 was part of a second major primary sequence. I believe that this is wrong.

I've discussed it in past issues. Moves like we saw this year typically occur in the final throes of a commodity advance, not the beginning; and there is no sign of a sober interruption to the trend on this chart. The argument is usually posited in the light of the length and depth of the correction in gold stocks during 2004 and the first half of 2005, or the other currency prices of gold. But the gold stock corrections that occurred during the 1969-70 and 1975-76 convulsions of the primary trend were twice as steep and long. In both instances, while the corrections themselves only lasted 10-12 months and averaged more than 50% according to the Barron's Gold Stock Average, it took three years for the average to make new highs. We haven't seen corrections like this yet but we will! The question is, will they occur now, or later? What I'm saying is that I believe that the view that gold has begun the second phase of its long term bull cycle is faulty and may suggest some complacency about the implications of a correction here.

Most of the signs suggest that we have seen a blow off in the FIRST primary bullish sequence for gold, and the commodity cycle more generally, within the context of longer term bull markets. There are two bullish technical facts outstanding nonetheless. First, despite the palpable but brief signs of froth in the second quarter of 2006, if the commodity cycle is predominantly driven by monetary trends but the markets impute a different premise - such as Hubbert, or the China story, or whatever else the experts say is driving the cycle when they get their two minutes to dumb down to the public on the boob tube then bullish sentiment could still have scope to grow.

It could indicate, as I suspect it does, a fundamental mis-pricing of relationships within the commodity spectrum.

Second, based on the historical account of the 1962-80 bull market, gold prices tend to peak only once the stock market averages have finished collapsing. The gold price peaks in December 1974 and 1979, as well as 1987, occurred after the Dow had finished making declines of 45%, 25%, and 27% respectively (chart of S&P 500 and gold prices as well as gold stocks and money supply provided elsewhere in report). During 1974, for instance, the peak occurred almost precisely at the same time as the Dow bottomed. During 1980 and 1987 a Dow rally was already underway again by the time gold prices peaked, but importantly, Dow declines had just occurred.

Those are just two missing pieces to the current quagmire that keep me bullish on the intermediate outlook.

Technical Analysis: Gold Prices, Short / Intermediate Terms

In June, when gold prices fell through US$600, they broke a bullish 10 month intermediate trendline for the trend that began in August 2005. After warning of a correction back in the second quarter of 2006, I nevertheless saw it as anomalous, as it was a reaction to hawkish central bank rhetoric, the reality of which I thought would not see the light of day - given circumstances. Thus, I had expected a quick recovery, and new high, rather than another intermediate correction, at least in bullion; I eventually accepted that an intermediate correction was upon us in the gold shares, most having discounted a US$900+ gold price on the HUI's previous run to 400.

But what we got was a retracement rally back up to the previous trendline (see the straight line in the graph), slightly piercing it, followed by two further short term bullish failures, then another test of the 200-day moving average - the next important intermediate trendline measure - which looks a little shaky as trend support. At the moment the trend is neutral. The previous 10-month intermediate uptrend has halted and either we are going to get a new one or a bona fide downside reversal, the confirmation of which would occur on a break through the US$535-542 handle (see the horizontal line in graph), which is likely to see a test imminently if the US$570 level doesn't hold here, but actually is already implied in the objective of the short term July-August triangular formation that gold prices fell out of on September 11th.

Some relief in the oversold general commodity trends or a down turn in stock prices, or a news related catalyst, could easily give bulls the psychological fuel to muster another assault at the resistance levels between US$615 and US$640, but if they do not break through them, it could be construed as another failure, in which case a test of the final intermediate support point at US$535 would be typical, hence likely. If bulls can successfully recover ground above US$640, on the other hand, it puts into play another, more neutral looking, consolidation/triangle, as opposed to the bearish descending triangle formation which would come into better view below US$570.

However, the sequence of events on the chart is currently bearish, and our short term outlook is bearish until the bulls can recover the aforementioned levels, or at least until we hit the US$535 level. The burden of proof is now on the bulls to reverse the current message in the chart (don't shoot the messenger!). They might have to buck the evolving commodity and currency trends to do it. The bottom line is that the chart doesn't look great, and that support between US$535 and US$570 is crucial for the intermediate term bullish case to hold. There has only been one fake breakdown (bear trap) since 2001, which occurred in 2004; it didn't fool us at the time.

But I may not want to forgive a failure to hold intermediate support (US$535) on this particular occasion.

Most of the time, the chart has worked well in this market and I think at this juncture, in light of the many things that are discussed in this report, it should be heeded. Thus a break through this support would imply a target in the mid to low US$400's. A substantial decline like that would herald the end of the first primary gold advance.

My subjective outlook for the intermediate trend is tentatively bullish. But my short term outlook, discounting the suggested attempt to recover bullish territory, is bearish unless the bulls prove me wrong by taking out US$615, or until the market tests the US$535 mark from where we could see the bulls mount another assault on the old 1980 high at around US$800, assuming our ultimate valuation and stock market cycle hypotheses are correct.

Thus, my short term view essentially reflects my posture of putting my bullish intermediate outlook on notice.

Of course, support may actually be at US$525. Markets work that way, and it might be too late to sell anyway by the time they break that level to signal a primary liquidation. We've recommended enough selling (of gold shares) and think the risk justifies holding our reduced position. The size of the consolidation (triangle) implies a move to US$856, technically, if gold breaks out on the upside; or a decline to US$395 if it is to the downside.

I am betting it will be to the upside, but the charts are not confirming me yet, and the risk of error is higher now - due to the maturity of the primary sequence, the breakdown in the CRB, as well as trends in key monetary facts and in inflation expectations. Of course, aren't bull markets supposed to climb such walls of worry?

But What Does History Say about the Relationship between Gold Stocks and the S&P 500?

Whereas gold prices have historically peaked after important stock market bottoms, gold shares have tended to peak somewhat earlier. As you can see in the charts above, they went down with the general market in two of the four (shaded) instances of S&P 500 corrections during the last great gold bull market era (1962-80). What does appear to be a workable rule in this particular historical relationship is that as a sector the gold stocks were more likely to advance during general market downturns when they did not rally too strongly before its onset.

Thus, in 2001, for instance, when some prognosticators called for gold shares to fall with the rest of the market, they did not take into account the fact that they had been in precipitous decline since 1996. Many things about this cycle have been reminiscent of the seventies, and 1973 in particular, except for the fact that the gold share ascent in 1973 started after the stock market turned down, not ahead of it like today. Sticking with our rule, this means that whether one is expecting the current inflationary boom to morph into a non-inflationary Kudlow like bullish advance in stock prices (replete with falling gold prices) or whether they are anticipating an Austrian style bust for the economy and stock market (replete with rising gold prices), it doesn't look good for the gold shares.

[To be sure, higher gold prices are usually bullish for gold shares; the exception that proves this rule correct is when stock prices turn down and gold shares are overbought in the primary sequence ahead of the downturn.]

Could it be different this time? Sure. But the rule makes sense. The bullish scenario within the parameters of this rule is that both gold and the stock market continue to move higher together. However, I think this view is untenable on separate grounds. It would require a rate CUTTING campaign by the Fed starting yesterday that would be bullish enough to boost stock and gold prices but not so bullish that the bond market falls apart on it.

Anything is possible but my bet is with a good old-fashioned Austrian style bust that takes gold shares back to cheap territory, despite higher gold prices for the duration of the concomitant collapse in stock values. Gold stocks have consistently been among the most rewarding sectors to be long for the past five years, even though most producers could not report a growing stream of profits until gold prices crossed US$500 late last year.

The improvement in their operating fundamentals is a bullish fact by itself, but valuations are still ahead of these results, and are vulnerable to a correction for reasons that have little to do with current or long term profit trends.

Gold Stock Technical Update

A classic head & shoulders top may be forming in the one year sequence (with the neckline at between 275 and 280) near the top end of the trend channel that I've identified on the long term chart. On the other hand, due to the downward slant of the neckline, it could just turn out to be a sequence of lower lows as outlined in the graph.

If it is the former, there is risk down to just below the lower long term trend line at around 200, or even slightly lower. As already mentioned, this size of correction is not atypical in a primary gold liquidation. However, if it is the latter, the case could be made for a target level slightly higher: 225 to 250 - small consolation, undoubtedly.

Either way, unlike gold itself, the intermediate charts in the gold share indexes already reveal a distinctly bearish bias. Indeed, many gold stocks within the averages have started to front run a break down in the HUI with a break down in their own sequence including Goldcorp, Meridian, Harmony, and Newmont, as well as numerous small cap names. Others have traded down to their necklines and are toying with one even as I write.

There is very little to get excited about in the valuation and technical attributes of gold shares at present.

That could change, but right now they are looking increasingly bearish in the intermediate outlook.

The average may coil some more before continuing one way or another. My outlook is for the HUI to make a lower low as gold prices fall to test intermediate support at US$535, then to rally back with gold, but it is not likely that new sustainable highs will be seen for some time in either the HUI or the HUI/Gold ratio. This outlook suggests that investors should look to rallies as opportunities to scale down their positions further down to core.

As with many commodity sectors, they are probably oversold in the short term and it may be better to judge this situation in terms of technicals after this week's widely anticipated and hoped for FOMC relief rally in everything.

Fundamental Fact: Fed Money Growth < Foreign CB Money Growth Bullish for Greenback, Sooner/Later

The USd chart is starting to elicit signs of a bottom relative to other currencies if only due to extended disparities between the rates of monetary expansion in the US and overseas since 2003: the European, UK, Canadian and Australian central banks in particular have been growing money (broad) at rates two to three times as fast as the Fed (see graph below). Indeed, the last time that the Federal Reserve inflated at a slower clip than its G7 peers was during the late eighties, and between 1994 and 1997, which may have set up the late nineties dollar rally.

It is quite possible to use the statistic in the chart below as a leading indicator for USd foreign exchange rates, at least for the longer term cycles. Notice that big surges in relative US liquidity tend to occur alongside rallies in the US dollar (depicted by shaded columns). But if you assume that the effects of an extended relative increase in money creation can take a couple years to work themselves out in different trading zones, then declines in the US currency would logically eventually follow higher than peer inflation rates, especially the longer it's sustained.

[Note(1): G7 average is an unweighted mean using data from the G7 central banks: BOC, RBA, BOE, BOJ and ECB (the latter two would weigh most in a weighted mean); Note(2): M3 is not consistently defined across the spectrum and in most cases includes components the Austrian School would not classify as money, such as large time deposits or repurchase agreements that constitute credit; Note(3) for the US we use MZM mainly because M3 is discontinued, though it is a better proxy of broad money than M3, but less comparable since the other central banks do not publish an equivalent component.]

One could argue, for example, that the 1982-84 surge in this statistic paved the way for the greenback's decline between 1985 and 1987; or that the period of 'relative' weakness in this statistic between 1987 and 1996, except for the three year period between 1992 and 1994, was the secret to Rubin's success with the strong dollar policy that saw the greenback later post a significant advance between 1996 and 2001; and that the relative excess of US monetary policy between 1997 and 2003 laid the groundwork for the decline in the US dollar after 2002.

Still, it is a poor timing indicator and forms only part of the overall fundamental picture.

It deserves only some weight, enough to add another cloud to the bullish gold outlook. The length of time and extent of the gap between inflation rates in the current trough only offsets half of the excess of 1997-2003.

But it could be enough to give a half-decent bounce in the greenback some substance.

Before I get into the specific technicals of the USd, recall that gold price swings tend to foreshadow swings in the US dollar index. I want to remind you that in 2005 I said that gold prices would advance irrespective of what the greenback did, as the exchange rate reached our original primary target (the 1992 low). This was because we found that historically although the USd would start to decline after a gold price rally got underway, it would stop declining by up to two years before the primary gold price sequence completed despite the relationship staying consistent for the intermediate swings. Indeed, the intermediate gold price advance that got underway in 2005 began to discount an intermediate downturn in the greenback months before it materialized in 2006.

The fact that the USd index did not make a lower low on the new highs in gold prices, though, suggests that the historical model is consistent, and only confirms the view that the five year old primary sequence in gold prices is mature. The currency has been basing now for over two years. Moreover, the limited extent of weakness in spite of gold's second quarter surge bodes well for the bottoming hypothesis. And finally, the current weakness in gold and commodity prices, particularly if it gets worse, could be somewhat of a catalyst for the dollar bulls.

A lot of investment has diversified outside of the US in recent years, and a weakening in the US economy could reduce import demand, cause a wave of capital repatriation from foreign markets, and fix the trade balance all in one fell swoop. At the end of 2000 I argued that the declines in US financial markets would take the US dollar down, but the situation was different back then compared to today: global portfolios were overweight US shares then; USd sentiment was overly bullish, seemingly unbreakable, and USd monetary conditions were bearish.

The housing and commodity boom, unlike the tech boom, are not a wholly American phenomenon.

The bearish facts facing the greenback are that I am potentially wrong about the effect of a stock market rout on the currency, and the general trend is still away from the USd as a reserve currency, though still in benign form.

This, combined with our long term inflation outlook, suggest new lows for the currency eventually; but there is a good case for a bear market rally to come alive in the interim, based on the above factors, and below technicals.

Technical Analysis: USd Coiling for Bear Market Rally?

The USd is in two holding patterns: one in the short term and one in the intermediate term.

On the short term charts I have detected bullish sweeps in June and in September occurring within what looks like a 5 month ascending triangle, though confirmation of this formation requires a break out through the 87 handle.

On the longer term charts, the index appears to be basing in an intermediate head & shoulders bottom formation, which also needs confirmation in terms of a break out through the neckline at about 92 on the index (see horizontal line in the chart). So far, the bulls have successfully tested support above the neckline of the last short term ascending triangle at about 84 (see Nov 2004 to April 2005) confirmed by a subsequent breakout in mid 2005 that failed at the higher neckline. So the patterns are still neutral but the bias is slightly bullish, more on a break up through 87. A break out through the intermediate neckline at 92 would imply an advance to 105, or to somewhere within the shaded area in the chart (above 100). In percentage terms that would represent a material move and profitable enough trade, but it would still only represent a partial recovery of its post 2000 losses. Nothing goes straight up or down and the bulk of the evidence suggests an ebbing in the main bear market trend for this currency is potentially near.

The Euro is basically the inverse of this graph. The Canadian dollar appears to be losing some momentum in its four year (primary) advance against the US dollar, but has been the only major market currency to rally against it during the past two years while the USd was busy basing against most of the others. I don't think this shows any particular strength in the CAD because it was a late bloomer - having started its advance one year after the other foreign currencies, it doesn't surprise me that it has continued for a while after the others had peaked.

But the rally has thinned, and the currency stopped making new highs against the USd back in May.

The Yen, Swiss Franc and South African Rand have been the weakest currencies in the intermediate sequence, but they could be due for a bounce in the short term, making it difficult to call for a rally in the dollar quite yet.

The Yen and Rand even appear to be oversold.

I think the trade that is most attractive in the intermediate outlook, among currencies, is to be long the Yen against the Canadian dollar - which for most traders would mean buying the Yen (long) and selling the CAD (short), each against the USd, and particularly if you are bearish on the energy trade over that time frame.

The excerpt above is taken from a newsletter produced by The GoldenBar Report for private clients: http://www.goldenbar.com/.