Short-covering of the Dollar.

I'm a little stunned by the amount of dollar bullishness that's built up over 3 whole days of upside in the dollar index that haven't even managed to put the index back above its 50 dma or above its most recent peak on July 29. A sentiment shift of that magnitude without equally bullish price action is generally a very bearish setup.

Equally stunning is the amount of bearish sentiment on gold and commodities because of this 3-day rally in the dollar, which likewise hasn't generated equally bearish price action. Consider that, despite the dollar index's rally back up to over 79 (a level last seen on July 30), commodity prices remain well above the levels that they were at on July 30th. See the chart below of the dollar index, gold, the CCI equal-weighted commodity index, WTI Crude oil, and silver.

In other words, commodities (especially silver) aren't giving up the gains that were won on the dollar's decline below 79 in proportion to the ground that the dollar index has recovered. And that sort of stickiness in the face of what “should be” bearish is actually quite bullish. Now compare that “stickiness” in gold and commodity prices to the action last July/August when the dollar first began to rally and how commodities (ex-gold to some degree) absolutely collapsed at the first hint of dollar strength.

I have no doubt that many dollar bulls/dollar deflationists are hoping for/looking for a repeat of last year's dollar rally and the ensuing collapse in commodity prices, but thus far the action doesn't support that outcome.

On the contrary, the action would seem to support the idea that the recent rally in the dollar is more than likely just another big bounce based on short covering ahead of the FOMC. And the trends that prevailed before the FOMC (i.e. - a weak dollar and rising gold and commodity prices) will likely continue post-FOMC.

Those trends may even accelerate if the Fed follows the BOE's surprise move last week and increases the size of its monetization facilities, which wouldn't surprise me in the least given the Treasury's “default or debase” dilemma. It would be a big surprise to the market though, just as it was back in March when the program was first announced.

GOLD AND S&P.

GOLD appeared to be breaking down early last week, the metal reversed offsetting the stab down and recaptured its 50 day moving average. Last week left an outside up week in gold and any extension this week looks as if it will trigger a move out of a bullish Cup & Handle pattern.

This pattern exists within the pattern of a short-term inverse head and shoulders pattern as well as a larger inverse head and shoulders pattern. Last week’s turnaround in gold sets up a potential move over resistance in the way of a long declining 3 point trendline. A breakout over triple tops will trigger a Rule of 4 Breakout which has a strong likelihood of follow through. As many of you know panicky moves often times culminate at/near the 49th period of a move.

The crashes of 1929 and 1987 being good examples as the crash in both instances occurred 49 to 55 days from the high day. Looking at the weekly chart of gold, I see how the two most important peaks on the chart occurred 49 weeks apart. October will mark 49 weeks from the last important swing low. Will it be a spike high if gold breaks out?

While gold is poised to break out, the stock market is coming off the July Jolt. Despite the seeming bullishness of the outside up month of the S&P, the market has entered into the time period where a reversal could occur.

I don’t know what the catalyst for a reversal would be anymore than I knew what the catalyst would be at the March low. I still don’t think anyone can point to anything other than hope in a heavily oversold market that turned stocks around in the spring. The reason why any downside reversal must be respected is that it could be larger than most participants expect: bull and bear trends often play out in three’s---I don’t see 3 drives to a low on the monthly chart of the S&P which raises risk on any turndown in the Monthly Swing Chart in August.

Because of many cycles and patterns including 1979, 1929, 1990, and 1999 (the DJIA topped in August and double topped in January the next year) which I will flesh out further later, I believe that the July Jolt will lead to August and a September Surprise... to the downside

How China Dumping U$D For Hard Assets.

If you have massive coal reserves, an oil project in Kurdistan, or a boatload of gold bullion, China wants to talk to you.

The Chinese government holds over $2 trillion in reserves. The dollar is an asset that has lost 33% of its purchasing power since 2002. And with the U.S. government creating boatloads of easy credit with low interest rates, the long-term picture is even grimmer.

Those reserves are a liability, and the Chinese want out. Here's how they're fleeing the dollar...

China's coal imports are 2.8 times what they were last year. As of May, oil imports were up 14%. Imports of iron ore and copper are reaching record highs. And it's not just raw materials...

In February, China Development Bank loaned $10 billion to Petrobras (the Brazilian national oil company), $15 billion to OAO Rosneft (a Russian national oil company), and $10 billion to Transneft (Russia's national pipeline company).

So far this summer, Aluminum Corp of China invested $19.5 billion in giant base-metal miner Rio Tinto. China's national oil company Sinopec paid out over $8 billion for Addax Petroleum's oil fields in Iraq and offshore Africa. And the state-owned China Investment Corp just bought a $1.5 billion stake in metals producer Teck Resources.

China is dumping dollars for all kinds of hard assets and commodity infrastructure. It's also dumping those dollars for gold.

From 2003 to April 2009, China secretly increased its gold reserves by more than 75%. Today, it's the fifth-largest sovereign gold holder at nearly 34 million ounces. That's over 30 times the amount of gold the Chinese government held in 1990.

Right now, that much gold is worth about $32.6 billion – just 2% of China's total dollar reserves. China's frantic to exchange more of its trillions of dollars for gold. But only about $150 billion in gold bullion trades in a given year. The government can't put all its dollars to work in the bullion market without driving gold prices to the stratosphere.

That's why China is pouring resources into its domestic mining industry.

The Chinese central bank buys all the gold Chinese mines produce at a fixed price. In 2007, China produced about 9.7 million ounces of gold – making it the world's largest producer ahead of South Africa, which produced about 9 million ounces.

China's the world's third-largest country, covering about 3.7 million square miles. That land is incredibly rich in mineral wealth – it potentially holds over 320 million ounces of gold.

Only a handful of public companies are working with the Chinese government to expand the country's production. Those companies will reap huge rewards as China dumps its dollars into its domestic gold industry.

Sino Gold (SGX on the Australian Exchange), for example, is a $1.2 billion China-focused gold miner. It owns two operating mines with two more under construction. The company's remarkable ascent began in 2001, when it acquired a small project called Jinfeng. In just six years, Jinfeng went from a rough one million-ounce resource to the country's second-largest gold mine.

It would be difficult just to permit a U.S. mine in six years, let alone bring it into production.

China's government is so eager to get its hands on more hard assets, it's willing to go to almost any lengths to kickstart its mining industry. That kind of support can yield tremendous returns for smart investors.

Gold, ABOVE $1,000 This August.

Neither corporate debt or stocks are rising because the economy and financial system have been magically cured by money-printing. But when the Fed prints enough money to make literally everything “money good” when it comes to their value in debased dollars, everything can rise for some time. Let’s not forget that stocks tend to do quite well during hyperinflations; it’s just that gold, hard assets, and claims on hard asset do even better.

Speaking of gold, we saw another 1% (10.38 tonnes) capitulatory sale on Wednesday by the GLD ETF . As I’ve noted before, 1%-plus one-day sales of bullion by the ETF are rare and tend to be capitulatory when they occur. The last one-day, 1% sale (also 10.38 tonnes interestingly) was on July 8, which happened to mark the July low as I noted at the time in Gold correction is coming to an end.

Given that ETF sale and several other indicators I watch, I tend to think the odds are high that we saw another important low in gold on Wednesday. If so, it should now set the stage to challenge the $1,000 mark sometime in August.