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September 2, 2010

The most compelling development of the Thursday session is not the continued strength in equities, although I will touch on that below. Nor is it the appearance of a breakdown in the long bond chart, although, once again, it is a topic to be considered. The key action today was exhibited by silver, which posted its highest close since the brief pop into the March 2008 high.

Silver Daily

The white metal has been displaying firm relative strength against gold recently, and appears to be in the beginning stages of a fantastic move.

Gold-Silver Ratio

As with previous parabolic moves, we can expect silver to lead the precious metals complex higher. The immediate implication is that we should soon see gold break to a new high, an expectation that fits very well with our cycle interpretation.

Gold Daily

Since gold is barely $10 off its all-time high, it would be hard to imagine price being contained by that high if the daily cycle is setting a peak a week or more out. In fact, during parabolic moves, gold's daily cycles often run extremely right-translated, so it's conceivable for this cycle to run another 3 weeks or so before rolling over. We will monitor our usual indicators for a cycle peak, but the objective will just be to keep a beat on things. I have no desire to trade around daily cycle declines during a parabolic move.

As mentioned, equities continued their display of strength by once again closing at a session high. More importantly, they did so in the face of a slew of short-term overbought readings, so we can stack even more confidence into our call for a daily cycle low having been left behind.

SPX Daily

The "you are here" marker shows the spot after the launch of the last daily cycle that had similar overbought readings. As you can see, when psychology turns, oscillators get rolled over. Anyone looking for a short-term trade would be better off buying oversold readings into the first dip of the cycle rather than trying to fight the tape here.

Overall, I continue to expect this daily cycle to roll over soon after eclipsing the previous cycle high, set last month. To supplement our list of indicators that the cyclical bull is dead, an ominous sign is developing in the bond market.

USB Daily

As I cautioned after last Friday's slump, it is hard to tell at this juncture whether the bond action is just trying to shake off some riders before a final spike higher or whether bonds have rolled over in earnest. Either way, a chart I received today thanks to a subscriber has me even more convinced that this run is nothing more than the blow-off ahead of a secular trend change.

Source Unknown

Once the bond market breaks... meaning a long-term trend shift has occurred... interest rates will be heading higher no matter what the Fed throws at us. Keep in mind that bonds prices are sensitive to only two factors: economic activity and inflation expectations. With the economy in the gutter, a shift in the bond trend will therefore coincide with a shift in inflation expectations, and rising inflation... whether real or only anticipated... is going to weigh on equities.

You can see how all these developments fit like puzzle pieces with another expectation I've been expressing in recent letters: that as the dollar collapses into its 3-year low early next year, stock prices will not rise as many expect, but rather follow the buck lower. The tipping point will come as the perceived effect of inflation on corporate profits starts to outweigh the liquidity effect. At that point, money will flee dollar-based assets such as Treasuries and U.S. stocks and pile into perceived inflation hedges... precious metals and other commodities.

I'll conclude by elaborating on yet another expectation presented in previous letters. As the dollar's decline becomes critical and the economy becomes more deeply mired in depression, folks are going to come to the realization that all the money printing exacted by the Fed was not helpful, but rather malfeasant. They are going to realize that there was no stimulus package at all, but rather a distribution of tax dollars to the politically-connected... that despite all the rhetoric, the current administration has done nothing to stimulate job growth, but rather put greater hindrances on hiring by paralyzing corporations and small businesses alike with uncertainty and red tape.

This loss of faith will augment the sense of crisis... perceived by all and quite real for many... which will chase investment dollars into safe haven plays. However, the standard safe haven, Treasuries, will be grossly out of favor. Instead, all that money will chase precious metals, a market much too thin to handle the panic volume usually absorbed by the Treasury market... at least at current prices.

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