Feb 17 2009 10:35AM

Over the last two days, gold has beaten back the skeptics and the shorts, blasting through key resistance at $930. But if this rally forces the big, over-committed shorts to cover, we could see much higher prices in the near future.

Sometimes, gold just impresses the hell out of us. Despite a number of bearish short-term factors, the metal has barreled ahead -- pushing all the naysayers aside and positioning itself for a major rally higher.

Let's review some of the factors that were weighing heavily upon gold in recent days...

First, as I reported in this month's Gold Newsletter, Mark Hulbert's reading of investor sentiment, and other similar measures, were registering inordinate bullishness among analysts who try to time the gold market.

From a contrarian point of view, this was an extremely bearish short-term indicator for gold. Hulbert claims, in fact, that it is historically 95% accurate in forecasting the short-term direction for the metal.

Even as I noted recently that gold rose $30 in the two day's after Hulbert published his sentiment figures, I had to acknowledge his point: with so many bulls already committed, it would be hard for gold to attract new buyers.

Second, as our contributing analyst Gene Arensberg just reported, the large commercials trading on the COMEX boosted their combined net short positions by over 12% in the last weekly report, even as gold traded sideways around $900 and the total open interest decreased.

In other words, the large commercials, who are generally regarded as the savviest of traders, were placing ever larger bets that gold would fall in price. As Gene noted, this was a bearish signal. Important point: Gene also noted, as I've also stressed over the years, that when the large commercials are wrong, they are spectacularly wrong. (More on this in a moment....)

Third, Asian physical demand, particularly from India, has all but dried up. In fact, it may have actually reversed, as record-high gold prices in local currencies have pulled private gold holdings into the market. Gold scrap supplies are actually growing in markets that heretofore have been among the world's deepest supply sinks.

As respected trader Dennis Gartman noted yesterday, "High prices have drawn scrap to the market. Until this wave of scrap gold selling is finished, the price of gold shall struggle to make its way through the resistance at $925 to $930." (thegartmanletter.com)

And finally, we had that resistance level at around $930, a technical barricade that had been defended by ferocious selling on every previous assault by gold. Perhaps it was the comfort of having this previously impenetrable barrier that prompted the large commercials to bet so heavily on a gold retreat.

The week began with all these bearish shackles holding gold back. Now, with the metal boundlessly racing ahead, it all seems like so long ago.

Now let's review what gold has accomplished over the past two trading sessions, and what it bodes for the future.

Yesterday [Feb. 10], gold began the day in London well under $900, and threatening to fall lower in the correction that many were predicting.

In fact, in the caption to a front-page chart illustrating gold's inability to pierce upside resistance, Dennis Gartman worried that "We find it disconcerting that spot gold has been unable...or unwilling...to push upward through $925-$930...and that the public, especially in the Middle East...is selling scrap gold into the market. Further, doesn't this look rather like a 'head & shoulders' top?"

However, instead of fulfilling the bearish concerns and technical indicators, gold began rallying smartly just prior to the New York opening, eventually gaining $20.30 on the day to close at $915.30 in New York trading. The rest of the precious metals complex followed suit, although the gold stock indices were dragged lower by overwhelming weakness in the broader stock market.

Of course, the passage of the stimulus bill by the U.S. Senate and the announcement by Treasury Secretary Timothy Geithner of the Obama administration's non-plan to rescue the American financial system both had significant effect on the equity and gold markets. The prospect of the greatest orgy of currency creation in world history, combined with little hope of resolving the credit crisis anytime soon, led investors to abandon stocks for the safety of gold.

But the fireworks really started today [Feb. 11].

While stocks rebounded from what had to be regarded as an extremely oversold level, gold began adding to yesterday's gains right from the start.After gaining about $10 in overseas trading, the metal fell back to show about a $6 gain in early New York trading. But by midmorning, the price began leaping higher.

At last check, gold had gained $23.50 (2.57%) to $938.80 bid, after trading as high as $948. In the process, it had utterly smashed through resistance at $930, and proven that this rally is for real.

The rest of the metals, and the mining stocks, followed gold's lead eagerly. At last check, silver had gained $0.39 (2.97%) to $13.53, platinum had risen $35.00 (3.39%) to $1,068, and palladium inched $2.00
(0.95%) higher to $213. The Gold Bugs Index closed 23.33 points (7.93%) higher to 317.48, while the XAU added 8.65 points (7.00%) to 132.14.

Why the big jump today? Apparently, it was a good question, as Mark Hulbert issued a commentary today to pose that very question...and was able to provide no clear answer.

Hulbert noted that it would be easy to say the gold market is predicting an imminent "economic catastrophe," but that explanation might be too easy. In fact, he wondered why, with all the terrible economic events in the interim, why gold was higher in July than it is now.

Although Hulbert didn't see it, the answer is fairly obvious: the dollar.

As I wrote in this month's Gold Newsletter, it was no coincidence that the dollar bottomed, and gold peaked, at virtually the same instant last March. Since then, the dollar has carved out a counter-trend rally while gold has been able to trace out only successively lower lows.

The timeless see-saw relationship between gold and the global fiat reserve currency (the U.S. dollar, in the current example) was maintained. As the dollar trended higher, gold trended lower.

Until now.

In truth, it seems we are witnessing a major trend change. As you can see from the accompanying chart of the U.S. Dollar Index from my good friend Ron Griess of TheChartStore.com, the dollar appears to be topping out. In truth, it seemed that a longer-term decline was underway late last year, as the reality of the upcoming currency reflation set in. But that decline was apparently reversed by a period of euphoria, as the markets awaited the hope and change of the new Obama administration.

Now that the bloom has come off that rose, it seems like the dollar is headed back downward. More important has been the leap higher in gold. The importance of gold breaking through the last interim peak of $927 achieved last October was illustrated in yet another front-page chart on Dennis Gartman's letter of today. Dennis noted that gold had essentially broken the longstanding downtrend line and -- just hours removed from his worries over a head-and-shoulders top -- was poised to add to his gold position.

Drawing On A New Well Of Demand

In short, gold is looking very good from both a technical and a fundamental standpoint right now. Granted, Hulbert's concerns regarding an overly bullish level of sentiment are valid. But the previous accuracy of his readings may not be as relevant these days, since the very character of the gold market has changed dramatically in recent months.

Consider that gold has always been a relatively tiny investment sector, with only a very small percentage of total available investment funds ever allocated to it, and an even smaller percentage of analysts paying attention to it.

Part of the problem was that only sophisticated, or very determined, investors bought the metal, either through the futures exchanges or bullion dealers. Now, with the advent of the gold ETFs, that's all changed. With a click of a mouse or a phone call to a broker, a Main Street USA investor can buy a gold or silver ETF and -- mistakenly or not -- feel like he's stuffed coins under his mattress.

In other words, a huge new market, one potentially as large as the market for equities, has opened up for gold and silver. And the penetration of this market is growing by leaps and bounds, as the holdings of the ETFs set new records on a daily basis.

Individual investors are now buying the metals alongside the institutions, and these new players don't really care what the professional market timers think about the market. They're just buying gold, because they're worried about the future, and because they simply feel its value is going to rise.

And in doing so, they're answering Hulbert's essential question of "with so many bulls already in, who's left to buy?" The answer: The huge, untapped market of investors who never could, or would, buy gold before.

It is this new source of demand, what I call "Western physical demand," that is not only rescuing gold from the lack of "Eastern physical demand," but propelling the metal higher.When the Asians began buying again...which I expect to happen as the dollar weakens...look out above.

Is The Fuse Lit Under The Gold Market?

Finally, let's address the situation outlined by Gene in our last Alert. In particular, what does this rally from $900, through technical resistance at $930 to nearly $940, mean for the large commercials who have been piling their short positions ever higher?

I'm not sure -- but I know it can't be good.

For one thing, that $930 line of firm resistance has now become support. So the short positions put on around $900 or lower are deeply underwater, and likely to remain there for some time.

Today's swift, intraday move from $920 to over $940 may be evidence of some short covering already being accomplished. (Hopefully not, since we'd like to have as much fuel as possible remaining in the rocket.)

Regardless, the large commercials' cumulative short position has been too large to be significantly covered so quickly. In the past, when these players have shorted gold heavily and been wrong in those bets, the results have been some of the most dramatic rallies of the bull market.

So...if you consider the large commercial short position to be a fuse, it's safe to say that today's move has put a match to it.

We may see some profit-taking tomorrow. But the recent action in gold will attract some trendfollowing speculation, so it seems likely that the gold rally will continue over the intermediate term.

And that means more good news for gold stocks -- not only the senior producers, but also the junior exploration companies. The juniors have been showing some life lately, and investors have been more inclined to place some bets. With a number of companies rushing to get good news out before the big annual Prospectors and Developers Association of Canada (PDAC) show at the beginning of March, I expect some dramatic news over the next few weeks.

So stay tuned. Things are finally getting interesting again.

--- Brien Lundin