What’s happening with gold & when will it bounce?

On Friday morning we warned investors that they “need to be prepared for one last washout in the gold market, during which the price falls by $100-$150, or perhaps even more”, and by mid-afternoon this move was underway. This article looks at what it was that moved the market and tries to determine the level at which gold will find support.

For several weeks it was clear that gold was heading for a retest of $1,525, a level that had acted as major support since the September 2011 all-time nominal high of $1,923.70. In fact, on 3 April we identified a repeating corrective pattern that could take gold down to $1,525, the only question was whether or not that level would hold. On Friday, not long after trading opened on the New York Comex, we got our answer.

Why did gold plummet on Friday?

What has left so many analysts and commentators baffled, is the fact that gold sliced through major support at $1,525 on a day when there was essentially no news.

On Wednesday US investment bank Goldman Sachs sent a note to their clients advising them to go short gold, however their report, which was written by Damien Courvalin and Jeffrey Currie, was almost entirely devoid of analysis. There was no mention of the recent announcements by the Bank of Japan or the $85 billion a month being created by the US Federal Reserve. In the report the pair wrote, “In fact, should our expectations for lower gold prices continue to prove correct, the fall in prices could end up being larger than our forecast.” To quote Michael Pento, “I would throw the report in the garbage, or you can line your bird cage with it. That’s about all it’s worth”.

On Thursday there were reports that the European Commission had ordered Cyprus to sell 10.36 tonnes of its 13.9 tonnes of gold reserves. However, the news of the sale of 400 million euros (£341 million) worth of gold bullion did not phase the market.

Friday itself was essentially a no news day, and yet gold only briefly found support at $1,525 before falling all the way to $1,480.50 by the close of US trading. The 5.1% drop was followed by a further decline as trading continued in Asia.

Once gold broke major support its fall was likely exacerbated by a massive increase in short selling and the fact that gold officially entered a bear market.

Everything is fixed

Investors on Wall Street seem to believe that because stocks are back at all-time highs and the US housing market is “in recovery”, everything is fixed.

Donald Selkin, chief market strategist at National Securities Corp. in New York, noted recently that “The perception is that gold is not really needed as a safe haven. People are looking at the stock market and they’re stunned, and there’s no inflation. So people are saying ‘What do we need gold for?’”However, as we pointed out recently, that thanks to massive money printing, it is possible to have a booming stock market and a weak economy simultaneously.

For those that care to look there are plenty of signs that the US economy is far from healthy. Since the recession officially ended in late 2009, 15 million people have joined the federal aid program SNAP (Supplemental Nutrition Assistance Program), formerly known as the Food Stamp program, which provides financial assistance for those purchasing food.

Over the last six months the US national debt has increased by $750 billion. Meanwhile GDP has only increased by $115 billion, and at the same time the savings rate in the US has once again begun to fall. During the first quarter of 2013 the personal savings rate dropped to its lowest level since the start of the recession. Americans saved 3.6% of personal income in Q1, down from 4.2% in Q4 2012 and a near-term peak of 6.2% in Q2 2009.

How low will gold go?

Last month we said that investors who are holding physical metal, but want to protect themselves against further short-term declines, could do so via put options. Those that followed the strategy are now “in the money” and can profit from this sharp selloff in the yellow metal. The question is, how low will gold go?

The selloff in gold is highly likely to continue today, and although it is unlikely, gold could fall all the way to the long-term trend line shown on the chart below (purple notation).

A 17 year monthly logarithmic chart of gold (Click on the chart for a larger version)

A 17 year monthly logarithmic chart of gold (Click on the chart for a larger version)

Chart courtesy of stockcharts.com

As we wrote on Friday morning, “For those still holding gold this event will feel terrible”, however this purging process, known as the “puke point”, is a necessary evil.

It is only when the last of the weak-handed longs has thrown in the towel that the speculators who are short gold will move to cover their positions. This short covering (together with purchases by central banks in Russia, China etc.), will bring tremendous buying back into the metal and could mean that the decline in gold is quickly reversed.

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