Could we be on the verge of the next deflationary crisis? Ben Bernanke said he’s still concerned about deflation. The financial system is still under pressure with high unemployment, foreclosures, and defaulting credit. There will be further sovereign debt issues from Europe and further weakening in real estate as defaults continue to rise. This tug of war between deflation versus inflation seems to be an ongoing cycle and we may have further news out of Europe surface soon.

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You can observe the chart of the dollar the cycles of deflationary periods versus inflationary periods. The dollar is reaching extremely oversold levels and a price floor, which means we may see a dead-cat bounce. This may put pressure on gold and silver temporarily. It will provide further market entry points for precious metal investors who enter the trend when gold and silver is on sale and oversold, reaching long-term trend support.

There may be further dissent from central bankers to complete a new round of asset purchases unless we see further debt issues from Europe. Many are concerned about the deteriorating dollar and the rise in gold and silver. This indicates investors are concerned about the stability of the US currency. This lack of confidence in a sustainable recovery will put into question the past monetary easing of the Fed. The quantitative easing isn’t making a sustainable recovery and producing any real economic growth. Although the equity markets have recovered, it’s been a direct result of the dollar collapse. The housing market isn’t showing signs of any improvement from the record low interest rates and still hasn’t been able to penetrate its 200-day moving average.The unemployment rate is still high and the devalued dollar is putting further pressure on wage earners.

The falling dollar also has hurt emerging markets that rely on a favorable exchange rate in order to export goods. Recently the Bank of Japan had to intervene to push the yen lower. However that was short-lived as the market shrugged off that news item and reversed higher. Although the Fed’s monetary policies may be good for the equity markets, they’re not making a significant impact on the average American. The rapid decline in the dollar will spark further pressure on emerging economies especially in Asia. This decline in the dollar will increase merger and acquisitions in the natural-resource sector as many Asian nations who are becoming net importers of certain commodities are trying to increase their supply. Although the downtrend in the dollar is confirmed a short-term bounce from these oversold levels may occur, which may provide further buying opportunities in gold and silver.

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The S&P 500 is appearing to show signs that the rally is losing steam. The MACD is making a bearish crossover and the significant rise without any pullbacks shows an extremely volatile move that could see a nasty pullback. The breakout of $114 — which I didn’t expect to occur — seems to be a fake breakout. The breakout occurred without forming any real base. Thursday appeared to be an outside bar day, indicating that the uptrend of September is losing strength. The price volume action is bearish and now the MACD has made a bearish crossover. Stochastic indicators have also signaled a sell signal from extremely overbought levels. Caution needs to be exercised.

Although gold and silver may be under pressure from a weak equity market and dollar dead cat bounce, I believe it will provide another opportunity for precious metal investors to enter the trade at a more reasonable level.

One lesson I’ve learned as a trader is that if you don’t know what the trend is, don’t make a guess. Even a four year old child who looks at a price chart on gold can spot the uptrend.  However, in the  case of the major market indices- where you have a declining 5o day moving average below the 200 day moving average, and when you are seeing poor price volume action- it is best to be cautious. There can be impressive rallies before a bear market begins.  The Dow Jones Industrial Average is overbought and has crossed the 200 day moving average on light volume.  This has come after major bouts of selling from institutions including the infamous “flash crash in May.”

The way I measure how excited a market is through volume.  A break above key support or resistance on low volume indicates that the move was not convincing and should send warning signs as a “fakeout”.  This market is indicating that the moves higher are basically due to a lack of sellers and any further news items which may be negative will bring the bears back out.

Housing is an area which is seeing very little demand right now.  This is the industry which initiated the financial crisis we are in and it should be showing signs of strength in an economic recovery.  Much of the rise in housing was the result of government intervention in the form of tax breaks offered to buyers.  The rise in treasury prices and the weakness in housing indicates that many people are not borrowing.

Although housing appears to have a double bottom, I am a bit suspect of the lack of volume.  It would be premature of me to call a buy signal on housing, especially since it has not tested the 50 day moving average as resistance after the bearish death cross of the 5o day crossing the 200 day.  Housing needs to turn positive before any real rally can begin.  Right now housing stocks are still bearish and a convincing break above the indices would change my mind, but the probabilities of that occurring with these overbought conditions and lack of volume are low.

There was a report this week about executives of bailed out banks who were paid $1.6 billion dollars of taxpayers money.  As investors realize the staggering debt and the stagnant economy we are facing because of high taxes and increasing government intervention into the private sector, there will be major move away from cash and towards gold and silver.  At that point gold and silver could move significantly higher.  I believe that time may be closer than many sources would have you believe.

To summarize, some indexes have broken the moving averages to the upside but on low volume, as I have shown in the first chart.  To me, this indicates that smart money is staying on the sidelines until the trends are more observable.  Right now, my bias is that this rally is  a fake-out and I will not become bullish again until I see a break above 10,600 on the Dow as well as a bullish golden crossover of the 50 day crossing the 200 day moving average to the upside.  Volume is a crucial part of this equation.  If there is some major accumulation coming coupled with the 50 day moving average sloping higher, then I will reconsider my position.  However, at the moment I am still bearish on the markets and am bullish on silver and gold.

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