Dear CIGAs,

The combination of a sharply lower dollar and a somewhat higher-than-expected CPI reading, was enough to send gold sharply higher as it plowed into some upside buy stops that sent it into resistance centered around the $940 level. The move higher serves to confirm yesterday’s move away from $900 validating that as a key technical support level and furthering the consolidation pattern on the gold price chart. It will take a closing push through the $940- $942 level to set up some further upside for gold.

It is interesting to note that this consolidation pattern is tightening and forming a broad triangle which is the pattern that we often see in gold before it commences its next leg higher.

All is hinging upon the US Dollar and whether or not it can hold support above the double bottom support that emerged in early June near the 78.40 level. A closing breach of that level and gold will break out of this triangle and move towards the $1000 level. I might add that when looking at the weekly chart of the US Dollar, there is not much in the way of technical chart support below 78.40 until you get closer to the 76 level.

One can say that for today at least, the inflation play is back on and the deflation play has been shelved. The PPI from yesterday and the CPI from today was enough to at least temporarily put a lid on the deflationists while the sharp move lower in the long bond has added further credence to the inflationist stance. As mentioned so many times of late, these two competing ideologies are driving our markets and until one side bests the other, these sorts of wild, dramatic price swings are going to continue with the US equity markets moving up or down as one side or the other prevails for the day and the Dollar reacting accordingly as “risk” is either in favor or out.

Our old indicator of risk, the Euro-Yen cross, was sharply higher today with the Yen getting knocked lower against the majors, including the Dollar, much to the delight of the Japanese monetary authorities who continue grumbling about “excessive volatility in the Forex markets which is not warranted by fundamentals”. Translation – “we are getting ticked off at the hedge funds who keep bidding our currency higher and are getting ready to kick their collective asses”. When this cross is higher, more often than not, commodities are higher across the board as the fund algorithms kick in.

Copper in particular stormed higher today and looks like it will try to make a run towards its recent high near 2.45. I am not sure if it can break through that level but if it does, it will indicate that the sentiment in the commodity markets is shifting more firmly in favor of the inflationist argument.  It has been slowly grinding higher and while it looked for a while as if the Head and Shoulders pattern shown on the daily price chart was about to be confirmed, yesterday’s and today’s move higher has negated that, at least for now. Traders will be closely watching it to see how it performs tomorrow and Friday in order to gauge the next move in that bellwether market.

Open interest in Comex gold continues to remain relatively stagnant. That is not unexpected seeing that range-trading or consolidating markets rarely attract much “interest” in today’s momentum chasing environment. For our purposes however it is extremely healthy as it gives end users in the real gold world more time to become acclimated to a higher price level. Physical gold buyers and sellers do not like wild volatility – they like price stability as it gives them a range in which they can feel comfortable making their buying and selling decisions.

After moving higher on fears of deflation and especially as a result of convexity buying, bonds imploded on inflation fears moving rates higher once again, much to the consternation of the Fed, I might add. The short term moving averages have flipped down with today’s session low near the 40 day moving average providing some buying support. It looks to me like the bonds are going to be carving out a trading range like many of the rest of the markets until this deflation/inflation argument gets sorted out.

Crude oil is running higher today with prices moving back above the $60 level. It would certainly not hurt the cause of gold were crude to establish a floor near this level as that would help ease fears of deflation. It is difficult to make a case for gold as an inflation play when crude oil prices are moving lower as energy is such a key component in the cost structure of our economy.

The HUI put in one of those nice bullish formations on its daily price charts but still has much work to do technically to convincingly assert the bullish case. Not until it gets a close above 360 can it be said that the gold stocks are out of the bear woods just yet. I want to point out however that it did get back above that 100 day moving average which means that the shorts are having great difficulty pushing prices lower as value buyers seem to be emerging.

I suspect that what we are seeing in gold and by inverse, the Dollar’s action, is increasing concern about the pace of reckless spending by the US government. Chatter about surtaxes on millionaires to pay for a government boondoggle called health care reform and an attempt to push a cap and tax program upon an economy that is reeling from a credit meltdown can hardly be said to be the thing that makes for balanced budgets and enhanced tax revenues. Corporate tax revenues have plunged an astonishing 57% and yet more punitive business measures seem to be in store. My view is that individual tax rates are going to reach 50% even as capital gains taxes are raised to 20%. There is no end in sight to the transfer of private wealth to the government and none of this is business friendly in the long term. Heaven help the US Dollar…..and by consequence, the future for our children and grandchildren.

Click chart to enlarge today’s hourly action in Gold in PDF format with commentary from Trader Dan Norcini