Gold Outlook: More Storms Before the Sun

by James Brumley | May 17, 2012 8:30 am

I hate to be the one to say I told you so, but I told you so: Gold was in real trouble.

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I made the point — and ruffled some feathers in doing so — back on May 3[1] by saying “I’m bearish on gold here and expecting that support line to break pretty soon. Mining stocks will follow that lead for a while.” I also opined the same back on March 15[2], saying “If (a key support line) fails to act as a floor, then I’m renewing my prediction of a move to $1,442.”

Great, but what was the “support line” I was talking about? It was the one that snapped on May 8, opening the bearish floodgates. The sellers haven’t looked back since.

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The nearby chart tells the detailed tale, but to fully appreciate just how big of a deal this breakdown is, you have to check out the weekly chart here. This was the support line that had been prodding gold upward since 2009. Now it’s broken, leaving traders more than a little uncertain about what to do next.

Of course, the technical event itself is academic at this point. As a student of the market, I’m more interested in (1) why, and (2) what’s next? The good news is, my answers to both questions are pretty straightforward.


As much as we’d like to pinpoint a specific reason why gold is melting down, the most meaningful answer is that its perceived value has been falling of late, rather than rising. See, as much as we’d like to believe otherwise, the supply of gold is in flux, the demand for gold is in flux, and the price doesn’t necessarily reflect supply and demand — it mostly reflects speculative opinion.

In other words, gold’s so-called “fundamentals” are philosophical at best. (Sorry, but it’s the truth.)

I can tell you why the perception of gold’s value is falling, though.

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There are two key reasons right now. One of them is inflation, or lack thereof. The whole reason gold started to flay back in mid-2009 was the assumption that a whole lot of stimulus and quantitative easing — which injected tons of money into the domestic and global economy — would lead to worthless dollars, and flood the economy with misleadingly-high demand for goods and services. It never happened, though. As of yesterday, the current annualized inflation rate is at a mere 2.3%, well below the long-term norm around 3% (or more). And it has been trending lower despite recent stimulus efforts like QE2.

The other reason traders are now shunning gold is a perceived slowdown in China. Between the country’s consumers going hog-wild for jewelry and the state’s accumulation of it for political/financial purposes, China had been gold’s biggest consumer. Since late March, though, red flags have been waving, suggesting that demand might be coming to a screeching halt.

Of course, if Greece does end up leading the rest of Europe over a cliff, it’s certainly not going to help gold, either.

And yes, that’s a 180-degree turnaround from the assumptions just a few months ago, when investors simply had to own gold because Greece was leading the eurozone into the abyss. The ensuing currency collapse would mean gold was the only safe haven. Now gold’s a liability. In retrospect, we can see gold was rising last year because of a weakening U.S. dollar, and is falling now because of a weakening euro. It’s a testament to the idea that there are no actual gold “fundamentals” … just ever-moving targets.

What’s Next?

The point is, the biggest reason gold is going lower now is because it’s going lower now. It’s not a complex or fancy answer, but it’s the truth — at least as I see it.

That’s not a bad thing. In fact, it’s good in that it lets us focus wholly on what the chart is telling us. Well, as of right now, the gold spot-futures chart is telling us the world’s favorite commodity is headed for a price of $1,442 per ounce.

I’ve mentioned that number before, but it merits a renewed explanation. It’s Fibonacci lines, which are — in simplest terms — the market’s organic support and resistance lines. The $1,442 level would be a 38.2% retracement of gold’s rally between late 2008 and late 2011.

While those kinds of assumptions might seem like some sort of hocus-pocus analysis, Fibonacci lines play a reversal role more often than you might believe. Besides, there’s nothing else to latch onto as a potential floor at this point.

To be clear, the $1,442 mark isn’t set in stone, and it might not ultimately stop the rout. I do expect it to be an inflection point, however, where the sellers stop and think and give the bulls a chance to regroup. Let’s revisit this chart if and when, which should be right about the time China stops its bleeding and inflation worries are reprised.

  1. back on May 3:
  2. back on March 15:

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