Posted: Feb 04 2010 By: Dan Norcini Post Edited: February 4, 2010 at 2:44 pm

Filed under: Trader Dan Norcini

Dear CIGAs,

Once again the usual, one-two punch against gold was the order of the day – namely an equity market that dropped precipitously and the rush to the “safety” of the Dollar. That combination overwhelmed any buying of size that had been making itself evident near the $1,080 level. I watched the first approach to that support region and the buyer/buyers who had been supporting the market did indeed show up pushing price back above from there as has been the recent pattern. However, the Dollar breaching the 80 level to the upside brought in another wave of selling and that simply swamped the bids down near $1,080 and downside support was breached. The bulls certainly ceded the hard fought advantage that they had been clawing away from the bears early in the week.

Incidentally, open interest saw a mild decrease yesterday but today’s crash no doubt will change that considerably. We have had a very good washout of stale longs which is healthy and had some traders, including myself, thinking that the worst of open interest drop off was over, but today’s action flushed another wad of them out. China and India will be pleased.

I find it ironic on the very same day that the USDX surmounts the 80 level that the headline across one of my favorite website reads,

“Pennsylvania State Capital Mulls Bankruptcy as a Budget Option”.

Let’s see – that now makes California, New York, Michigan, Illinois and Pennsylvania in the headlines within the last few weeks. But little ol’ Greece has debt problems so the Dollar is a safe haven. Yep –makes perfect sense to me. I think I am going to immediately rush out and buy all the Treasury debt I can get my hands on – I cannot think of a better safe harbor. Hedge funds probably won’t question the safe haven status of the Dollar until the headlines read:

“All 50 states considering bankruptcy as a budget option” or

“Punxsutawney Phil sees 6 more YEARS of winter – frightened by a Dollar bill that drifted by his hole”

Maybe then they will sell it.

Then they will probably point to Guam as a reason to buy the Dollar. It probably has not opted for Bankruptcy.

I keep waiting for an IMF bailout of the EU, Britain and the US!

Oh well, things are what they are and for now that means investors are in love with the Dollar (or less in “hate” with it compared to the Euro) out of default and that means the algorithms have to sell more gold as well as nearly every other commodity on the board. Copper, sugar, cotton, crude oil, natural gas, silver – you name it – if it was a commodity it was generally sold off today.

That being said, the failure of the bulls to hold the line at $1,080 means we get another leg down with the possibility of $1,050 as the next test. Gold so far is following the seasonal tendency for weakness in the month of February although the buying that had been coming in near $1,080 had given me reason to think that it might be well able to hold a range trade with that level as the bottom. Now we have to wait and see what level these buyers retreat to and where they tip their hand. For now, the order of the day is further long liquidation along with some additional fresh short selling.

The psychology that is working against gold for right now is that traders are yakking about the lack of inflation and thus their reticence to chase gold higher. So far this liquidity blast from the Fed’s Quantitative Easing program has not worked its way into the broader economy (yet). With banks not lending and tightened credit standards, upward pressure on prices has not been seen in a larger way. Wages are still stagnant and/or falling relieving any pressure from that source. That is the reason that the gold price is so tuned in to what the equity market is doing and why it sells off whenever the equities get clocked. The lower stock market is read by traders as a sign that the economy is not growing or expanding as quickly as the pundits would have them believe and so the upward pressure on prices across the economy fades and down goes gold. It really is that simple.

It is also the reason that the bond market has refused to break lower – bond traders simply do not believe any 5.7% growth rate nonsense or “V” bottom chatter. If they did, the bonds would have a 115 handle on them by now. Keep in mind however that the bonds also have not been able to break higher either. They are trapped in a range as supply issues continue to have a deleterious effect on this market. No one should forget that we have an Administration that has given us a projection of a nearly $3 TRILLION budget deficit over the next two years and that is assuming that some of their rosy growth projections actually materialize – I think that they are vastly overstating projected revenues. That is one helluva lot of Treasury debt that is coming down the road.

Of course, for at least 30 years traders have been conditioned like Pavlov’s dogs to rush to the Dollar at the first sign of economic distress so old habits die hard. Although these dogs are also learning a new trick – rush to the “safety” of the Japanese Yen. I still have to shake my head at that one (maybe we can create a new name for this trade – “ABTW – Anything but the West).

Whatever – that reflex then produces the computer spitting out of gold. All of this is short term “noise” however and the gold community has weathered this same thing time and time again over the last decade. Nothing really has changed except that gold is getting sold off from a higher level which means it will also find support at a higher level as it continues its steady climb higher. Where that new level of support emerges is unclear, but it will, just like it has in times past. In the meantime, believe it or not, let’s watch copper and see where it bottoms for that might give us a clue as to when this “deflation” based selling will subside.

One good thing out of all this hedge fund selling is that it is going to continue to give us cheap gasoline and energy prices. That will help with home heating bills this winter and consumer budgets not to mention lowering costs for the transportation sector. Then again, lower costs are good but what they really need is more business and more revenues, not just lower inputs. That is no way to grow a business long term.

The S&P is perched precariously on top of some critical support and if it takes out the 1066 level on good volume and remains below that level for at least an hour, we could see this market move swiftly down to the November 2009 low near 1025. We certainly are flirting with that level as I type these comments. That would not be much help for the gold shares were that to occur. Hedge funds with their ratio spread trades are probably making money out of this short leg in the mining shares that they are holding even as they take a bit of a hit on the bullion side of things.

The HUI chart stinks – not much more can be said than that. It has to get back above 400 to generate the least bit of bullish enthusiasm. One good thing about its technical picture ( and I am grasping at things I admit), is that there is another level of decent chart support centered between 342 – 348. That might hold it should it get down that low. It is trading below the 50 week moving average however so rallies are going to be sold until it can clear that level and recapture its footing above 400 and STAY THERE.

Please see the gold chart for the most recent technical levels.

Click chart to enlarge today’s hourly action in Gold in PDF format with commentary from Trader Dan Norcini