For a little more than a year now I've been telling you that the broad market and the economy have been in a state of transition. That transition period is now complete. After the start of the Iraq war we saw the beginning of a strong cyclical bull market that lasted for three years. A year ago, however, we began to see signs that the bull market was in the process of coming to an end.

The biggest danger signal I told you about last year involved the sectors that make up the market. Leadership in the market moved into the energy and commodities sectors. This kind of transition usually takes place at the end of a bull market. Consequently, the sectors that had led the market up until then - technology and Internet stocks - topped out and have been weak ever since. At the start of this year the vast majority of sectors were in the process of making stage three tops. Many are now in the red for the year.

Much of the strength in the economy and the market also came from real estate and home building stocks. The red hot real estate market has been our main source of economic growth over the past few years. Rising home building prices and refinancing has enabled consumers to increase their spending by taking on more debt in the face of rising energy prices and stagnant wages.

If you remember, a year ago, I mentioned that the CEO and directors of Toll Brothers, the largest publicly traded housing company, were selling shares of stock in their company like mad. The CEO himself cashed out for over $100 million and then told a reporter that he thought the housing boom was going to continue for years. He claimed he was only selling to diversify, not because of future business prospects.

Housing stocks have been falling ever since and have made no signs of putting in a bottom. Since the markets tend to factor in news 6-12 months later, we should start to see the slowdown in the housing market pickup by this Fall. Mortgage and financing stocks have also been in total collapse.

A downturn in the housing market will put a damper on the overextended consumer. It doesn't take a rocket scientist to see what is coming, just common sense. We are near the end of the Fed's cycle of raising short-term interest rates. Fed fund futures have placed the odds of another rate hike in August from 75% to below 50% last week.

The Fed is really in a bind right now. The lead time changes in FOMC policy and the economy is 8-12 months, so once the Fed sees signs of slowing in the economy it is too late to prevent the most recent rate hike from causing a recession. At the same time, inflation is a lagging indicator that appears most threatening while the economy is showing its initial signs of weakness. The need for the Fed to pause and take a look at what the future data signals is growing.

Over the past 53 years, there have been 12 periods in which the Fed went through a cycle of raising interest rates. In 10 of those times, the S&P 500 and DOW fell after the final rate increase, with an average drop of 22%. On average, the market bottom came 10 months after the most recent tightening. An economic recession also followed in 9 of those 12 periods.

We have seen the market go through several quick corrections over the past three years. Each time, several indicators that I follow hit extreme levels of fear or selling, the market put in a major bottom within days and then rallied to make new highs. For instance, whenever the ratio of decliners beat advancers and down volume outperformed up volume by a ratio of 9 to 1, we saw the markets bottom within a day or two, if not on that day.

But this past May and June, when the market fell, I saw multiple days like this in a row. That was a sign of massive selling. Not only that, but once a bottom appeared to be put in place, the market only rallied for a week and then turned back down to make new lows in a sickly and disappointing manner.

What is more, so far the current earnings season has been a major disappointment. Yahoo and Dell blew up in investor's faces while Intel, Ebay, and Qualcomm guided their earnings lower. Stocks even fell on good news as Caterpillar dropped 1.1% despite posting a stronger than expected profit report. This is the first time in years that we've seen earnings this bad. Fourteen percent of the 152 in the S&P 500 that have reported earnings so far missed estimates, which are usually set low on purpose by analysts so they can beat them in order to add some excitement to the stock.

The market began to act differently than it had in the past. And when the characteristics of the market changes you had better pay attention because it usually means that a state of transition has been completed. The market reminds me of the summer of 2000. That was the last cycle of Fed tightening and it led to a brutal bear market. The market made a quick and vicious correction in April and then tried to hold up all summer until it came unglued in the summer, falling to pieces, wiping out thousands of small investors in the process. This May and June correction reminds me of the action we saw in April of 2000.

We haven't gotten a nice rally or attempt at stabilization like we did back then - not yet at least. I still suspect that we'll get some sort of bounce for a few weeks into the August Fed meeting, as CNBC and Wall Street hype it up as the possible end of the Fed tightening cycle. If that rally comes, I will likely take some short positions against it.

The markets are oversold enough that it could begin at any time. The 60-minute stochastics for the Nasdaq are oversold and spent all afternoon going sideways on Friday. I wouldn't be surprised if we see a rally start from here.

We'll just have to see how things play out. In bear markets, the name of the game is survival as their end brings amazing opportunities to buy in cheap. A year from now, I expect to identify a dozen or so new sectors coming out of stage one bases to start new bull markets of their own. We haven't seen that in years and I'm really looking forward to it. But it's going to be some time from now.

But until that point comes, there are two ways I plan on making money - gold stocks and possibly by shorting some stocks once we get a rally for a few weeks in the market. If you try to short stocks you have to do it after a rally. Bear markets are prone to explosive rallies that come out of nowhere which squeeze shorts and trick everyone else into holding on. I don't want any part of that, too risky. So I have to be patient and wait for a rally that lasts for more than a few days to even consider shorting anything.

With the Fed near the end of its cycle of raising interest rates, signs of economic weakness, a dollar bear market, and a nightmare current account deficit it's hard to imagine a more bullish scenario for gold for the rest of the year.

The US dollar index put on a tepid rally along with the markets in May, but that rally appears to have run out of steam. The dollar index now has resistance at 87 1/2 and support at 85.50. If the dollar index breaks 84 I expect a big decline in the dollar to begin in it. That has been support for the dollar for over twenty-five years.

We've seen gold rise for the past several years and, this past year, we've seen the gold bull market become accepted by Wall Street and CNBC. However, there has been no mainstream analysis of the causes behind the gold bull market, with many popular commentators linking it to "jewelry" demand, commodities inflation, or the international situation. In reality, I believe gold prices have been rising ahead of a huge decline in the dollar.

Everything I've been writing about for the past few years appears to be dead ahead of us. Gold and gold stocks should take off. So be ready for another explosive bull run.

That didn't stop gold stocks from dropping last week though. It looked as if they put in a major bottom Wednesday, but then on Friday they disappointingly fell to break support as the XAU closed below 135. Its next support level is at 131.52.

Gold stocks fell at a slightly faster rate than the metal on Friday so it is likely that the correction will continue this week. In fact, the setup is very similar to what we saw going into Wednesday's open. But a gap down opening in gold should bring a bottom in the morning.

Gold needs to catch up with the recent drop in the stocks. Once it does, however, I expect the stocks to stabilize and rally right back up to their resistance downtrend line (145 for the XAU). They should then pause and go on to breakout and attack their 52-week highs.

What would be bad is if we were to gap up on today's action. A nice gap down in gold should finish off this correction. A gap up could lead to more selling like we saw on Friday. If we open down and then see gold for all a faster rate than the stocks - or at some point during the day the stocks stop falling while gold continues to drop - then we'll see real signs of a bottom.