Based on the October 14th, 2011 Premium Update. Visit our archives for more gold & silver articles.

At the beginning of the year Brazil warned that the world is on course for a full-blown “trade war” as it stepped up its rhetoric against exchange rate manipulation. Also known as competitive devaluation, a currency war is a situation where countries compete against each other to achieve relatively low exchange rates for their own currency. Currency issues have certainly dominated economic news so far this year. Just this summer Switzerland lowered the value of the Swiss franc, boosting gold’s role as a safe haven. Currency tensions between the U.S. and China have not eased over the course of the year. Legislation designed to press China to let its currency rise in value passed the Senate just this week. Americans say that China's yuan policy already amounts to a trade war that has decimated the U.S. industrial base with artificially cheap products.

Emerging market economies continue to grow, but that poses risks of inflation. China remains the 800-pound gorilla, with economists wondering how it will manage its rapid growth. That has mostly been the case this year. Fast growth has fired up the country’s economic engines, but it has also led to stubbornly high inflation. In March of this year, the Chinese government said that food prices rose by 11.7 per cent. Gold is considered a hedge against inflation and we have seen a rapid rise in gold buying among the Chinese middle class.

This year we saw social unrest, demonstrations and riots. Look at the so-called “Arab Spring,” the protests in Tel Aviv, Spain and Greece and the recent “Occupy Wall Street” movement in the U.S. which is spreading across the country. When there is unrest, people tend to turn to gold to protect their wealth.

Sovereign debt across the West is past danger level and it won't take much for people to lose confidence in their currencies and start trading them for anything of value (Gold? Silver? Platinum?). Hyperinflation has a single cause: it occurs when a government cannot borrow money because its debt has risen so much that investors believe they will never be paid back with close to the same purchasing power. As a consequence of this flight of confidence, such a government is forced to print money to meet its obligations. This further undermines the value of its currency, often culminating in a frenzied collapse.

So far this year we have not seen hyperinflation but plenty of lack of confidence in sovereign debt.

To see if at present this translates into increased confidence in precious metals mining stocks, let’s turn to the technical part starting with the analysis of the S&P 500 chart (charts courtesy by http://stockcharts.com.)

In the medium-term S&P 500 Index chart, we see a strong analogy to trading patterns from 2010. There is a possibility that we may see another move lower before the bigger rally begins. This would be similar to what was seen in August of last year and may be seen once again if history repeats itself.

This would be in tune with 2008 as well when a sharp bounce in interest rates was seen. Back then, the bottom in interest rates followed the final bottom for precious metals and preceded the general stock market bottom.

In the XBD Broker Dealer Index chart, we see a confirmation of the move above 80 and above the Fibonacci retracement level as well. Of course, this chart is a useful tool for identifying upcoming general stock market moves. Here, with the previous breakdown invalidated and the bottom likely being in, the implications are clearly bullish.

In the Correlation Matrix, the mining stocks short-term relationship with the general stock market remains both positive and strong. This means that higher prices in the stock market would most likely translate into higher prices in the mining stocks sector. However, considering the cloudy short-term situation for the general stock market this is far from sure.

Having considered the likely impact of the general stock market on miners, let’s move on to the analysis of mining stocks themselves.

Only one thing has changed in this week's very long-term XAU gold and silver miner's index chart. Namely, the breakdown below the rising trend channel has been invalidated and the index level is now clearly above the lower border. The breakdown below the highs of 2008 has not yet been invalidated. If and when this is seen, a very bullish situation will be at hand.

In this week's long-term HUI Index chart, we have seen a small pause in the rally. The question now is whether the next price move will be similar to the July and February upswings or the downturn in June. The current decline has been huge and should be considered for the April to June period rather than just April to May. The analogy best suited for the weeks ahead appears to be July and February as opposed to a comparison with June. Therefore, the decline is likely to be minor.

In the short-term GDX ETF chart, we have seen low volume levels coupled with a pause in the rally. This took place after the rising resistance level was reached and is therefore not a surprise. It is likely that this is not the final top for the current rally.

Please, recall what we wrote on October 7^th, 2011 in our essay on the possible rally in mining stocks:

The mining stocks have been on an extremely scary and volatile ride of late but their recent price action has not been a complete surprise. Although we would not say this was a most likely option, it was one which we knew was possible. Now that the support level has been reached, the odds of a subsequent rally are likely increased once the ratio breaks out above the declining trend channel and the move is verified. The situation therefore appears to be quite bullish at this time.

For the time being, we need to restate our point of view that a move up from here is still a quite good possibility.

Summing up, the situation for the general stock market appears to be bullish for the medium term but the short-term situation is quite cloudy at this time. The situation in mining stocks appears favorable based on the underlying metals and the self-similar pattern in the HUI Index chart. The influence of the general stock market should also eventually be positive although the short-term picture is presently unclear.

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Thank you for reading. Have a great weekend and profitable week!

P. Radomski

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In the latest Premium Update (the full version of the above essay) we cover the following:

• Long-term interest rates
• USD long-term trends,
• USD vs. gold
• Self-similar pattern on the general stock market,
• Financial sector
• Precious metals correlations (and changes in them)
• Big gold chart with an important long-term pattern being currently in play
• Gold from the non-USD and yen perspective
• Short-term pattern present on the gold market
• Silver's cyclical tendencies
• Platinum
• Thursday's decline in the precious metals sector
• Discussion on the volatility in the markets
• Targets for gold, silver and mining stocks

We encourage you to Subscribe to the Premium Service today and read the full version of this week's analysis right away.