Dear CIGAs,

Welcome back to the reflation trade and the end of “deflation” talk once more. The soaring equity markets and surge higher in the Euro was all that it took to flip the algorithms into the “BUY” mode for anything and everything including sea shells by the sea shore sold by Sally.

Gold shot up and initially hit a wall of selling below $1,080 which took it down earlier in the session but once the Euro began to gather upward momentum and the S&P 500 took out yesterday’s high, shorts in gold began a ferocious wave of covering that took the metal up through $1,080 and into preplaced buy stops which then ran price slightly higher before the bullion banks attempted to lean on it again. Their selling managed to cap it and take it back down below $1,080. It certainly does appear that there is substantial buying of the metal in the $1,040 – $1,050 region, buying large enough to absorb an awful lot of long liquidation. Again, just a reminder, India made its purchase of those 200 tons of gold not too far from that level late last year. China got caught flat-footed by their buy and will not make the same mistake again. The Central Banks of both these two nations are titans in the gold market so their footprints should not be too hard to discover, although they will attempt to camouflage their actions.

If you look at copper, it managed to claw its way above the $3.00 pound level further reinforcing the idea that Friday’s spike low marked a temporary end to the downtrend. It is not out of the woods yet as it will need to climb above the $3.15 level before bulls can claim victory over the deflationists but its chart is improved technically. Copper is still a bellwether for the inflation/deflation battle and that is the reason I bring this up. I want to watch the equities, the Dollar, particularly against the Euro, and copper to get a feel for how this inflation/deflation battle is shaping up and to measure which side is gaining the advantage.

The HUI finally showed some signs of life today taking out yesterday’s high and helping to reinforce the notion that it too might be temporarily sold out but I will not be confident of its gains until it climbs back above 400 and stays there for at least two full sessions. Those ratio spread trades have pushed the HUI/Gold ratio to rather low levels which should tend to work in favor of the shares should they trip some upside technical resistance levels. It looked like some of those spread trades were coming off today. If the HUI can hold its footing above the downtrending 10 day moving average near 386, that should begin getting some of the momentum traders interested in the long side. One day does not however make a trend so the jury is still out for now. We’ll see.

The Dollar was spanked hard today as RISK was back in vogue. Keep in mind that the Dollar has one of the largest, if not THE largest speculative net long positions on record. That does not necessarily mean it is due to collapse but what it does mean is that if any important downside technical levels are violated, a massive wave, and I do mean massive, of long liquidation will take place. This market is so lopsidedly imbalanced on the long side that the sheer weight of those stale longs could drop the Dollar several hundred points very quickly. The action in the Dollar, especially coming on the heels of Jim’s keen observations concerning the recent gathering of the money lords, is very interesting to say the least.

Technically, the Dollar looks to be vulnerable to what I described above should it breach 79 to the downside on decent volume. That has not yet occurred. The hedge funds that have poured into the Dollar are going to be tested to see how seriously they are willing to defend their boatload of longs. If they can successfully beat back the bears, it will be a credit to their willingness to commit vast sums of money to defend a fundamentally-based train wreck. Stay tuned on this one because it is a key market for us to watch.

Once again the bond market is displaying very unusual behavior considering the money flow back into “risk” trades. One would think that the sheer supply of bonds coming to the market to fund US spending orgies coupled with a surge in the broader equity markets would knock the props out from under the bond market and send them sharply lower with a corresponding move higher in long term rates. Not so! That alone is what makes the price action there so bizarre. I have said this before –based on what I can see occurring in that market, I am convinced that the US monetary authorities have their pals at work artificially propping up the bond market in an attempt to force longer term rates lower, or at the very least, prevent them from rising. The Fed and its cronies do not want to see higher interest rates, no matter what kind of blather comes out of their yakking mouths. (As I prepare to send these comments in bonds are finally seeing some selling coming in).

That is where the conundrum regarding the Dollar has its roots. They cannot have it both ways – a move higher in the Dollar will allow them to peddle their debt on the world markets a bit easier and make for lower yields on that debt. On the other hand, a stronger Dollar hurts US export competitiveness which is not at all helpful to an economy that is flatlining nor does it make it any easier to repay all this massive debt. A weaker Dollar helps to solve this problem but then yields become too low for prospective buyers and/or existing holders of US debt. That means that the bond market needs to fall to push up yields to make them more attractive which then stuffs the real estate sector. Pick your poison guys – you created this mess.

Crude oil has thus far put in a pretty good move higher, building on its gains after the spike lower into the $70 level. Any pickup in economic activity and thus energy demand should show itself on this chart, which so far is less than impressive as it remains range-bound between $70 on the bottom and $80-$82 on the top and has been now for some time.

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