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October 1, 2008

The Hunt for Gold October

Precious metals countinued their daily polarization as silver popped a couple percent while gold slumped one percent. Given that today's moves for each metal were in the opposite direction of the last two days of September, one has to believe the sharp price changes witnessed on Monday and Tuesday were related to the quarter-end liquidation of hedged positions. Regardless of the explanation, we have as our guide the charts, and the charts are not looking healthy. Gold experienced a failed rally for the second straight day:

gold chart

Of course, when attempting to get a read on the PMs, one has to have a feel for the dollar, as well, and the dollar appears to be in super bull mode:

dollar chart

I am of the mind that the dollar will continue higher. Why? Because the Senate is about to approve the $700B bailout package. [Doc pauses as a collective Say what? resonates from all the gold bulls reading this post]. The reason is simply that currency traders view the bailout as a stimulous package. Stronger economy equals stronger dollar... at least relatively speaking. You see, the U.S. may be in the deep end, but so is most of the rest of the world. The French are pushing a $422B bailout plan for the euro zone, for example, so against which currency will the dollar devalue? This interpretation is evidenced empirically by the fact that the dollar saw its biggest one-day rally ever a day after the House shot down the first version of the bill. The reaction on Wall Street was so negative, it all but sealed the bailout's approval its next time through.

The last objection a prudent trader may pose is: why wouldn't the bill's passage in the Senate be a sell-the-news event for the dollar? Well, perhaps it will be in the hours after the vote, but I have my doubts. Traders are still on edge about the fact that the House rejected what seemed like a sure thing. Once the bill gets through the Senate, I expect the relief rally in the buck to continue.

The relief rally goes for equities, as well, though I think any strength we see after the vote will exhaust the current bear rally.

index chart

If index futures pop 2.5-3% tonight, I will fade the move. Otherwise, I will wait for tomorrow's open and look for guidance. My assumption that the Senate will pass the bailout leaves me with a psychological dilemma, however. If I am wrong, I will have virtually no short exposure through what is likely to be another mini-crash... or perhaps bigger. I honestly don't know how well I would handle that.


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