How is everybody today? Well I hope. I would like to kick the week off with a look at what I consider to the most important inter-market relationship affecting the short-term prospects of the precious metals complex at present. If what this relationship is telling us unfolds over the next couple of weeks, we could be at our optimistic targets a lot sooner than one would expect.

What relationship am I talking about? It is one that's not commonly understood or followed, but has a dramatic effect on both short and long-term price trends in gold, and now has come to the center of attention for those who realize the more profound longer term implications of what is unfolding in the credit markets. What I am talking about is interest rates. And more specifically, I am referring to price/yield spreads. There are several different price duration spreads that are followed, mostly by professional traders, but we are going to focus on just the one here today, the one that is considered the primary measure. Of course I am referring to the spread between 10-Year Treasuries and 10-Year Agency Debt. When you put the two together you get a ratio, which measures the difference between the two. (i.e. the spread) (See Figure 1)

Figure 1

Can't put it any more bluntly than what is annotated on the chart above. A break lower means that everything is good in the world/economy, as debt buyers see declining risk in purchasing US debt, which means rates will fall as demand is good not only for government debt, but much riskier corporate debt as well. (i.e. corporate yields will decline/prices rise faster than those of government debt) And as you can see, the spread was down on Friday, closing on significant but not fatal support, and if we break lower it should bounce off of the next rail indicated, actually performing a test of the breakout from the symmetrical triangle at the end of August. This does much to explain the weakness in gold we have been witnessing over the past couple of days.

A straight linear measured move would take the spread just slightly above the highs seen back in late July, but I expect those highs will not hold for very long, and I would not be surprised to see the spread in the above reach eight points, which is a Fibonacci projection target, and an exponential incremental progression. (88 (32'nds) x 1.618 = 142 / 32 = 4.45 + 3.5 = ~ 8) If you want know where the value is in my services are you just saw it, as little gems like this last observation will not be found anywhere else on the web.

If I had to guess what is happening right now in order to prevent this important spread from thrusting up out of the triangle, I would think it involves a large degree of intervention from official sources. If they fail to hold the line, which I believe they will because of ever increasing strains on current trade relations in Asia, machinations/new revelations concerning budget deficits, along with a myriad of other factors converging presently to create a great deal of downward pressure on the US Dollar (USD) (i.e. a mountain of supply coming back in their face), agency yields could go through the roof sending prices plunging and taking Treasuries with them. A quick look at the dollar tells the story at present, as investors are going to want out of just about everything where the two letters US appear. (See Figure 2)

Figure 2

As you can see above, the dollar is perched on what could be termed terminal support, as if it breaks back into the descending channel indicated by the red dashed rail, which is the trend identifier for most, you can expect it to fall all the way to the bottom sine wave rail before it finds support. (Notice this coincides with pitchfork support dating back to the origin of the move back in 2001, as well) Currently, this would involve a move to the 85 area. Once the break occurs, and it will if the indicators above have any predictive value, expect the move to be very swift as this means the USD was trading outside of the channel divergent to some combination of factors, and in actuality should have been heading lower in the first place. Divergences are usually rectified in a violent and abrupt manner, this will be very good for gold. Why? A plethora of markets are going to quickly adjust to levels where they should be based on the fundamentals of current inter-market/international conditions. Just look at what the implications for long-term interest rates are utilizing the 30-Year US Long Bond. (USB) (See Figure 3)

Figure 3

Nothing is guaranteed in this life or investing that's for sure, but given the precarious situation the USD is in, along with a multitude of other factors giving one good reason to expect rates to rise from here (ex. commodity price inflation for one), there is no reason to believe the annotations in the chart above do not accurately reflect the path of least resistance going forward. If this occurs, the effect on everything from mortgage refinancings to the precious metals complex will be felt with the same increased magnitude of that being experienced in the credit markets. All that money coming out of bonds is going to have to find a new home and the gold will receive its fare share. (See Figure 4)

Figure 4

As you can see above, gold has traced out a sinusoidal wave structure which in fact dates all the way back to the origins of the bull move. If what the other charts are telling us is true, gold could literally bust a move here. Whatever that means to you, at least we know the harmonics identified in my earlier work point to the ~$425 area as the first stop this fall, although I am sure many of the precious metals investors would like to see it higher than that. The fan on the long-term monthly chart shows the $415 area as the next stopping point on a monthly closing basis, anything past that should be considered very constructive, as well as the beginnings of a right shoulder on a slanted inverse bottoming formation not denoted in the chart below. (See Figure 5)

Figure 5

The fan in the gold chart above is truly impressive and it looks as though the move higher up to the rail that coincides with $500 at present will be fairly controlled, but after this rail is taken out, gold should really pick up some steam to the upside. How long it will take to get through the $500 mark is certainly speculation at this point, but there is a darn good chance we will at least get up to that point sometime in spring of next year, based on my previous work available to you in the archives. It certainly is well within the realm of possibilities considering all that money coming out of bonds is going to have to be placed somewhere. (See Figure 6)

Figure 6

I think the annotations in the above chart pretty much say it all, and I am just noticing this piece is getting a little long in the tooth so I will keep the rest of it brief, as it is my intention with these commentaries to give you a good ten to fifteen minute information packed read to send you out on your day. And, this piece has certainly met my objective of bringing both some short and long-term scope together in order to for you to gain/maintain perspective. I hope I accomplished this for you today.

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That's all for today. Tomorrow we will be taking a confirmatory look at the current move in the precious metal stocks. I can assure you the results of some numbers I was crunching over the weekend, and the implications associated with those findings, will be pleasing.

Until then, be cool and hang loose. More good stuff for precious metals investors is on the near-term horizon.

Good investing all.

Captain Hook