Although the DOW and Nasdaq had gotten smashed by the end of last week, the week was fairly uneventful for gold stocks, which is where I'm invested. So I didn't make any changes to my positions. I didn't buy anything or sell anything. In fact, I didn't really watch the action that closely at all, spending most of the time working on the new website. Which, by the way, I expect to be beta testing next month.

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But things ARE going to change soon. The action is going to come back to gold stocks. The volatility in the stocks shrunk last week and when that happens a large move follows. You can see this in the bollinger bands on the chart of the HUI above as they are now pinching together. This means that gold stocks can continue to trade in a narrow intraday range for a few more days, but if they manage to do that the volatility will become so compressed that a big move will inevitably follow.

Of course, narrow bollinger bands and shrinking volatility may tell you to be on guard for a large move, but it doesn't tell you which direction that move will take. To try to answer that I've been looking at the above chart for some time.

After bottoming in June, the XAU has rallied all of the way up to the 150 area. It then encountered some powerful resistance at the 145-152 area which marked a 50-61% retracement of the peak in May and low in June. The XAU had to get to this area in order to confirm its bottom and reestablish its bullish pattern. It did that and did so quickly.

In each of the past few summers, we've seen gold stocks bottom in May and then rally back up to this retracement level after which they went sideways before breaking out towards the end of July or in August (remember how important XAU 95 was last summer). Those rallies led to powerful bull runs.

Last week, gold outperformed the stocks causing the XAU/gld and HUI/gld ratios to pull back. Usually this is a negative because these two ratios tend to lead the action in both the mining stocks and in gold. However, you can also chart out the ratio itself and it is now oversold.

What this means is that the performance between gold and gold stocks has temporarily gotten out of whack. (There are times when gold stocks lead the metal so quickly that they stall out in order for the metal to catch up with them, and vice versa. Either gold is going to pull back while the stocks hold up, or don't fall as much, or else the stocks are going to have to rally hard while gold doesn't move up.) At the same time, the 60 minute stochastics on the XAU became oversold on Friday and gold stocks rallied into the close, causing them to give a buy signal. This means that the short-term action should be up.

Combine this with the fact that the bollinger bands are suggesting a big move should begin by the end of this week, and we have two likely scenarios.

1)Gold and gold stocks either move up at the start of the week causing the XAU to go up toward its recent 150-152 resistance area. Both would then pull back for a day or two, during which the stocks hold up against the metal. Or else gold and gold stocks trade in a narrow range during the first few days of the week. Either way this action is still within low volatility, thereby causing the bollinger bands to narrow even more. Gold stocks break out and rally at a faster pace than the metal. Such a rally would take the gold stocks near their highs within a few weeks.

2)Gold retraces its recent gains to fall into the 620 area. The XAU falls with gold, but not at a faster pace. The XAU bottoms in its 139-140 support zone (the area of its 150-day moving average and 1/3 retracement of the rally from the June low). During and after this correction gold stocks reassert their strength over the metal.

What will be important is to see if the XAU can hold inside the range of its narrow bollinger bands. As long as it doesn't close below its lows of last week it will be lining up to break out to the upside. If they are still above their lows by the middle of the week and the bollinger bands are shrinking, I may add on to some of my positions.

I think the most likely scenario is a bullish breakout, despite the weakness in the XAU/gld ratio last week. The reason why is because we've seen this type of weakness happen for a week or two in every summer only to see the bullish pattern reassert itself.

Last year, for example, in July after the XAU rallied up its the 95 area, it went sideways all of the way into August. During this sdeways action, gold rallied while the stocks failed to move higher, causing the XAU/gld ratio to move down. Even though this happened, the stocks continued to hold support and eventually broke out.

The XAU/gld ratio can give false signals during times of consolidation in gold stocks. In fact, during times of consolidation in any market, false signals from technical indicators abound. That's because the market isn't trending up or down and many indicators are only reliable when there is a clear trend. When gold stocks are falling or rallying, the XAU/gld ratio is much more accurate than when they are just going sideways.

Instead, short-term support levels and the bollinger bands become more important. A move above or below the bollinger bands usually continues and that is what I have my eye on now and why I suggest the recent support and resistance levels on the XAU are what you need to watch.

The action this week is going to set the stage for gold stocks for the rest of the summer. If the XAU does not close above its last week's low this week, then it will be setting itself up for a powerful rally that will likely last all of the way into the end of the year.

Troubles in the Middle East pushed oil prices to a new high last week ($WTIC on the above chart is the price of oil). It looks like oil is going above $80 a barrel. Oil stocks, however, haven't participated in the rally. In fact, the price of oil has been rising at a faster rate than oil stocks all year.

I've been bullish on energy stocks for some time, but I find it hard to be excited about the sector as a whole now. The sector hasen't been up with oil and it is hard to imagine more bullish news for oil coming out over the next six months than there is now. When I zoom out and look at a three year chart of the energy stock sector, it looks like it is just going to trade in a range for the next few months. It may go higher and make a new high, but, even if it does that, it doesn't look like it is in a position to trend up for months (like gold stocks have the potential to do) so it's hard for me to get excited about it.

There are stocks in the sector that are worth holding and look good - especially the high dividend paying energy royalty trusts like BPT and PGH. And there are some other stocks that still look strong such as DPM, but money should be moved out of any lagging energy stocks and put to better use elsewhere.