If you think the past two days have been rough for the stock market, you must not have had any exposure to gold. For that matter, if you thought the gold bugs have had it rough, you didn’t notice that silver’s been absolutely shellacked this week.
The culprit? Ben Bernanke’s decision to start thinking about tapering off the Federal Reserve’s stimulus efforts. Namely, he’s now talking about cutting back on the $85 billion the Fed’s currently spending each month to buy U.S. Treasuries, a scheme that keeps interest rates low across the board.
But the real question is, how much more pain must gold go through before hitting a bottom and becoming buy-worthy again?
It Was Never About the Fundamentals
Truth be told, the last four years or so have been strange ones for gold.
Following the 2008 global economic implosion, the Federal Reserve and other central banks began to inject billions into their respective economies in an effort to restart growth. Those easy-and-cheap dollars were supposed to bring about a massive wave of inflation … but it never happened.
A sovereign debt fiasco that started in Greece but eventually bled into the rest of Europe was supposed to bring about a currency exchange meltdown, making gold the only true currency worth owning (particularly if the U.S. dollar implodes as was expected) … that never happened either.
Finally, if nothing else, gold’s been going higher since 2008 because many folks believed we never really escaped the recession. Since gold is in many ways an anti-stock-market trade, gold was simply seen as a smart way to play the re-entry into the bear market … of course, that too never happened.
Sure, gold had a great run, all the way through the third quarter of 2012. But with none of the reasons to own gold ever panning out, it’s no real surprise that gold’s been weak since the fourth quarter of last year.
The bottom line is that gold never rallied on its fundamentals. Gold rallied on speculation. That’s good news, however, since a speculatively-driven chart is much easier to handicap. In fact, the gold futures chart has very much behaved as an astute trader would expect if he/she would just take a step back and look at the bigger picture.
The same chart just dropped a big hint with this week’s plunge.
Crossing the Line
For those traders who are fans of, and familiar with, Fibonacci retracement lines, gold’s outlook can be summed up like this: Now that the 50% retracement level at $1,333.60 has been broken, the next likely floor and reversal point (the “target” price) is the 61.8% retracement line at $1187.90. That level was also a confluence of support and resistance back in 2010, making it an ever more potent line in the sand.
For those who aren’t familiar with Fibonacci lines, here’s the deal: Traders collectively tend to draw — and trade — the same mental lines in the sand over and over again. They don’t even consciously know they’re doing it, but they still act on them all the same. Those proverbial “enough is enough” points are Fibonacci lines. (That’s the simplified version. Here’s the full explanation.)
As for what that means to gold right now, the slide under the $1,333.60 mark pulled gold futures under the 50% retracement line … a retracement based on the span of the entire 2008-2011 rally. The next Fibonacci line is $1,187.90, which would translate into a relatively typical 61.8% retracement of the 2008-2011 rally. We should find support there — and once we do, the slightest perk up from gold will verify that’s a buy-worthy floor for instruments like the SPDR Gold Trust (GLD), the Market Vectors Gold Miners ETF (GDX), or perhaps your favorite gold miner.
Just for the record, odds are good we’ll see something of a dead-cat bounce from gold today, which may even bleed into next week. Don’t mistake that for a recovery. That’s just the shorts covering their positions to lock in profits, and perhaps a few bold buyers hoping the worst is over. Unless gold can actually move back above the $1,395 mark, we should see a rollover and a renewed move all the way back to the 61.8% Fibonacci retracement level near $1,187.90.
James Brumley does not have a position in any of the aforementioned securities.