Since reaching a high of $1,798 an ounce in early October last year, gold has been in a defined downward trending channel.
As the chart below shows, the price of gold has been bouncing around between the top and bottom of the channel and in doing so has formed a repeating pattern.
The pattern consists of a bounce off the lower end of the price channel which rises to around the half way point. This first up leg (green arrow) is then followed by a second test of the lower blue support line. Gold then finds sufficient buyers to propel it all the way to the top of the price channel before it then experienced a more pronounced and protracted selloff (red arrow).
The pattern has repeated three times, however during this latest occurrence, the price failed to retest the top of the channel and has already begun a sharp decline.
A 7 month (daily) chart of gold in US dollars (Click on the chart for a larger version)
Chart courtesy of stockcharts.com
Where next for the price of gold?
It now seems likely that gold will continue to drop until it retests major long-term support at around $1,525, at which point a number of scenarios are possible. The first scenario is that gold attracts strong buying and begins a new leg that will take it back up towards $1,800.
Perhaps a more likely scenario, however, is that gold rallies to around $1,650 before making a final bottom at $1,525 and then beginning the next leg of the bull market.
The last scenario is that gold fails to hold $1,525 and falls sharply lower.
The bottom line
Because $1,525 has acted as major support for gold for more than two and a half years, if the yellow metal fails to attract sufficient buying at that level it could quickly drop to around $1,400. As a result it may be prudent for those with large exposure to gold to hedge their downside using the put options strategy outlined here.