For months I have been expressing my bearish view on the gold market, telling followers and despisers alike that gold is setting itself up for a pending collapse.  The telltale signs are there, but everyone seems to get so caught up in the short term fluctuation that they fail to realize that gold is just toggling back and forth ahead of its next major move.  This near term consolidation doesn't prove or disprove any particular theory, but rather builds on declining volatility and overall market consolidation indicating a greater potential for an explosive price move in the near future.  I write this article as gold tests some critical pennant resistance, suggesting a selloff in gold prices is critical over the next two weeks to fill out the pennant and offer a breakdown below support.

The US dollar is also at a critical price juncture.  My forecast for a channeled US dollar (87-92) for the rest of 2005 is still alive and well, but current prices are near the lows of this forecasted channel and the market needs to find price support in and around 87 to hold up.  When the market does find support at these prices you will see a massive correction in gold.  Keep in mind the recent fallouts in copper, where a bull market failed multiple times for one day price moves that approached 10% declines in a single day!  This is far from impossible and even a likely event in gold if this consolidation pattern continues.  This week offers the potential for such a move, not only with critical price junctures in both oil and the US dollar, but also because of the FOMC meeting, bond auction, and plethora of economic reports to end the week.  If you look at a consolidation pattern and look ahead to what can break that pattern, then this week has breakdown with volatility written all over it.

Consolidation patterns indicate a market's pause ahead of a major move, proven by historical evidence in all markets.  This tends to happen frequently as the market digests new highs or lows, or if we see a lack of fundamental news to shift a market.  Gold falls into the latter category as it has set a high and a low based on the most recent action in world events and, in particular, in the US dollar.  One could debate that this pattern near the top of a long term uptrend is indicative of a market pausing ahead of fresh highs, otherwise known as a bull flag.  However, previous bull flags in gold over the past few years have not breached the long term arch and have not pressed the low end as aggressively as this current market condition.  Moreover, the longer the consolidation the greater the likelihood that the market will fail its current trend, and in this case that suggests that gold is due for a serious correction.

Put options are so inexpensive, not only because of the lack of speculative interest in playing the downside in metals, but also because volatility in gold has been decaying for months.  Gold is on the cusp of a major move, and if you are a long term US dollar bull like me you take these opportunities to reinforce your position at great entry points to play a downside correction.  I remain firm in my prediction for sub $400 gold and possibly a test of $360, and have yet to see a significant indication either way in the underlying shorter term price moves.  On an intermediate term view we are witnessing a test of critical resistance in gold and therefore an ideal short entry point utilizing puts to play a foreseeable correction.

James Mound, owner of JMTG Brokerage LLC, MoundReport.com and author of the book 7 Secrets, writes the Weekend Commodities Review Newsletter. Receive your free weekly subscription to the Weekend Review by e-mail. Click here.