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September 10, 2008

One Last Decline, then the Rebound
by David Nichols

September 9, 2008

It's shaping up to a bad few weeks in precious metals, as the final drop of this big corrective pattern is set to unfold.

Gold has been going sideways right near the recent lows, which is a generally bearish way for a market to consolidate after a strong move down. Plus there have been so many opportunities to break out over $815 - $820, and it's just not happening, which suggests that gold needs to go down further before the right sentiment mix is created for a strong rebound rally.

There are also a few other things that are not helping gold right now, as silver is looking very weak and the dollar index is looking very strong.

In the latest Fractal Silver Report (published on Monday morning for annual and 2-year subscribers), I discussed how silver looks ready for the next "free-fall" decline down to the final lows for this big corrective pattern.

Now on Tuesday it looks like silver is caving in -- as usual, ahead of gold -- so this is a big clue that the next hard down leg for precious metals is gearing up.

This next decline in silver should set up a monumental trade to the upside, as no matter what happens with silver down the road, the next immediate move should be a bounce up to the last major breakdown at $16.50. So silver is likely to move up over $5 on the rebound rally, which should be one of the most profitable trades of the year.

This is the "spring-loading" effect that I discussed in my last article, which is a very powerful -- and more importantly, predictable -- force in a highly speculative and volatile market like silver.

But silver is definitely not ready to be bought just yet, and a big reason for the weakness in precious metals and commodity markets right now is the strong rise in the dollar index.

The dollar index has been in launch mode since the mid-July bottom, which is wreaking havoc on so many parabolic up patterns tied to the dollar's decline.

It's also worth taking a moment to notice the very characteristic complex reversal pattern prior to the dollar's launch, and how the strong move started after the third major test of the initial energy levels of the pattern.

I talk about this a lot because it's very characteristic of the way markets behave during major reversals. Even though it's frustrating to live through such complex bottoming patterns -- especially on a weekly pattern, like this one -- the pay-off is usually extraordinary when the move finally takes off.

I'm expecting a similar sort of complex bottoming process for gold and silver at the bottom of this correction. My guess is the complex pattern will play out on the daily chart, and not on the weekly chart, as on the weekly chart the coming bottom will like more like a "V bottom" and a slingshot move from there.

Since the dollar index is so inversely correlated with gold right now, we can't really expect gold to turn around and head back up until the dollar index tops out. Right now I think the rally in the dollar will flame out in the low $80s, so there is a bit more room for this to extend -- which is what the weekly fractal dimension is telling us -- but the dollar rally is running out of time and energy.

Once the dollar index moves into the low $80s, it's likely to move sideways -- or come back down -- for a few months.

A correction in the dollar should send gold and silver soaring back up, but first we are likely to see one last major decline.

A quick-and-scary decline in this situation will be the best possible way to set up a massive rebound, so ideally we'll see a very large drop in gold over the coming weeks, and that will set up one of the best buying opportunities in years, either at $675 or $720. As always, we'll wait for our specific short-term buy signals around these target areas.

Please follow this link for more information on the daily Fractal Gold Report.

David Nichols
email: editorial@fractalgoldreport.com
Fractal Gold Report

David Nichols publishes the Fractal Gold Report, a daily report covering the gold market using proprietary techniques that go beyond technical and fundamental analysis. The Fractal Gold Report is available by subscription here. Fractal Gold Report Disclosure.

David Nichols is a graduate of Yale University and a leader in the emerging field of fractal market analysis. This pioneering analytical approach studies the markets as chaotic, non-linear systems, addressing the predictability in financial markets. Fractal market analysis discovers the order hidden within the seemingly random chaos of the markets.

David is the editor of the Fractal Market Report and the Fractal Gold Report, daily subscription newsletters written in an easy-to-understand style that cover the markets using his proprietary techniques that go beyond technical and fundamental analysis.

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