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Gold Set to Rock
January 30, 2011

By now, most Members have probably surmised that I am not purely a cycle trader. My methodology focuses on developing a framework of expectations, and then executing based on how the market action unfolds relative to that framework. Cycle theory is just one of the tools... and a powerful one... for developing the framework. My other tools include analysis of market history, a little insight into how big money operates, various proprietary technical techniques, and, of course, good old-fashioned subjective judgment.

Recent action in the precious metals market demonstrates just how effective this methodology can be. Roughly three weeks ago I suggested that gold's daily cycle would either 1) bottom quickly so that another daily could be squeezed into the intermediate cycle, or 2) run slightly long, bringing an end to the intermediate cycle. Various conditions contributing to the framework of expectations had me favoring the latter scenario, and I even published this chart to outline how that scenario could play out.

As we entered the past week, gold was sitting 24 days into that daily cycle, and the odds were strongly favoring the second scenario... if the first scenario were in the cards, gold should have had already formed a swing low. Besides, it seemed highly unlikely gold could produce four more weeks of lower prices with the dollar already breaking down into the terminal plunge of its 3-year cycle. Our framework, therefore, had us on the hunt for an imminent intermediate cycle low.

When a daily swing low finally appeared on Wednesday, I remained skeptical because of a bit of market history: several intermediate gold cycles during the course of this bull have ended with single-day panic sells occurring just after price had posed a false low. Furthermore, the neck line of an apparent rounded-top pattern sat just below at $1320 like a big, juicy steak tempting the wolves of Wall Street (or South Wacker) to gun for the sell stops. At that point we had nothing to lose, but a lot to gain, by exercizing patience. A break of the cycle downtrend line was only a few dollars overhead... a small price to pay for the potential of entering 3-5% lower if the expected run on stops were to materialize.

On Thursday, gold's collapse below the $1320 pivot produced an action point because our framework encompassed the expectation that such a plunge held a high-probability of forming the ending move of gold's intermediate cycle. With the anticipated behavior in hand, it was time to execute. Trying to guess the exact low at that point would have been counterproductive. I used a simple volume indicator to pick an entry point and started accumulating.

I should stress that there is no guarantee this week's low will prove to be the intermediate low. We play a game of probability. Our framework provided what appeared to be a high-probability play, and we took it. Using pure cycle theory, Wednesday's daily swing low was actually a reasonable spot to guess at a low because the swing occurred late in gold's daily cycle. More conservative traders, in fact, will not even have a position, yet, because the daily cycle trend line is still intact, and we have no weekly swing low. Both signals would occur about $20 north of Friday's close.

Gold Daily

Gold Weekly

For the record, I used Thursday's panic to bump the Docfolio's PM exposure up to about 120%. I plan to take on a bit more risk once further confirmations are delivered.

The stock market is in big trouble:

SPX Daily

NDX Daily

If the equity cycle fails, stocks would be facing 5-8 more weeks of generally lower prices. What's worse is that the decline could get nasty rather quickly. Despite rather solidly bullish dumb-money sentiment readings from, there is no shortage of traders calling for a correction. The market has frustrated most of them by being perniciously unaccomodating through January. Once a lower low is set, the exit doors won't be wide enough to handle the rush. What is the liklihood of another flash crash? Probably only about 10-15%, but that is 9.99-14.99% higher than it should be, thanks to a malfeasant central bank.

We now have a daily swing low on the dollar index:

DX Daily

During the primary declines of the last two intermediate cycles, all left-translated daily cycles peaked in 2-4 days, and I expect this new cycle to be no different. With less than one index point separating Friday's close from the DX 79 pivot, we could very well see this cycle peak Monday, but Wednesday should mark the latest spot to call a top. I believe the decline will become even more severe from that point, and I intend to push my dollar shorts.

Quite a few new subscribers joined the ranks this week, so I wanted to point out to them that The Big Picture is usually updated well before the weekend letter is published (for those in need of an early fix!). Due to travel, however, this was not the case this week. I'll have those charts updated later this evening.

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