By Jim Donnelly, Olson Global Markets

Although a continuation of the rally in the U.S. dollar index (DXY) over the past few months had been expected to keep a lid on precious metal prices, the Philadelphia Gold/Silver Sector Index (XAU) has defied that theory. Clearly, there is an inverse relationship between precious metals and paper currencies of all types. However, after staging a solid correction from the December 2009 peak, the bid for gold and silver has remained relatively firm as both the Euro and British pound have sunk. By contrast, the DXY has gained strength versus each of those currencies during this period.

Still, global buyers as well as speculators taking a longer-term view of the prospect of mounting sovereign debt obligations have not apparently lost their appetite for gold and/or silver. Neither have saver nations like China and India.

Evidence of this situation can be seen by looking at a chart of the XAU on the weekly time frame. With weekly stochastic studies now rising bullish, the XAU appears poised to break, possibly, above key “mid-channel” resistance at 173.50. If it does, such a “break” would have very bullish implications for precious metals in general, and gold and silver in particular. A failure to do so, on the other hand, would be reason to reevaluate.

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By Jim Donnelly, Olson Global Markets

Along with likelihood that the U.S. Dollar Index (DXY) has more room to move on the upside, it also appears that the converse of that thought is likely as well. Namely, that the Philadelphia Gold/Silver Sector Index (XAU) has more downside ahead of it.

After hitting a high of 198.32 on December 2, 2009, which tested key “channel top” resistance, the XAU reversed direction and later sliced below “mid-channel” support at 164.10 on January 21, 2010. With long-term (monthly) stochastic studies still falling bearishly at this time, the prospect for a test of key “channel bottom” support at the 138 level appears probable over the next couple of months. Moreover, by the time such a test occurs, monthly stochastic studies will likely be in an oversold condition. If that proves to be the case, the decline in precious metal prices may end for the intermediate-term.

Nevertheless, a decline to the 138 area would represent an additional erosion of nearly 10% from Friday’s 153.42 close in the XAU. In addition, it would represent roughly a 30% decline from January’s 164.10 peak.

In any event, such a scenario would favor the expectation for a further rise in the value of the greenback as well as additional declines in both the S&P 500 Index and the Dow Jones Industrial Average.

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