Gold had become extremely overbought in May, with the HUI breaching 400 for the first time since this bull began. As is typical for this market, it also overshot in the selloff, which took the HUI down to 270 in just one month!. With the war between Israel and Lebanon, it wasn’t surprising to see gold starting to recover from the selloff, retracing 60% of the loss to 350. But what has been surprising is that it has since given back 60% of that gain (hello Fibonacci) and has been sputtering at attempts to take off, when conditions seem ripe.

So the big question is: What’s Next?

We believe a massive battle is going on behind the scenes between US interests that would like to see a lower gold price (indicating inflation is in check) and foreign nations diversifying out of dollars. This is a major contributor to the intensifying roller-coaster ride, along with uncertainty over the direction of the Middle East conflict.

Gold stocks will surely take off if the war escalates, but if things settle a bit, this artificial support will be removed and the downward pressure could be substantial. The fact that gold hasn’t taken off supports the theory that strong downward pressure is being exerted.

So we have reduced our precious metals holdings to under 50% of total portfolio value. This is still aggressive due to our mid and long-term targets, but will keep the powder dry and ready to take advantage of the envisioned decline. Put simply, we believe the downside risk is much greater than the upside potential and recommend a cautious short-term approach. But we are staying prepared to buy in again quickly, as we believe corrections will continue to become shorter in duration. Furthermore and unfortunately, we don’t see any hope for a cease-fire in the Middle East.

If gold is headed lower before moving higher, we expect this correction and subsequent basing to be relatively quick. While the war will remain the wildcard, we see the next big leg up to begin by mid-November, even if some resolution is reached. This next leg up, keeping with the Elliott Wave theory, will be the largest we have seen to date.

We are making a silver play via large purchases of warrants in Silver Wheaton. Expiration in November of 2009??? Do you think silver will test $20 sometime in the next 3 years? Easy money with impressive leverage. Info on Silver Wheaton Warrants

((Action)) We picked up series A warrants (SLW.WT.A) for $1.21US.

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