Gold could fall all the way to $1,350 - but watch the euro

Gold, which has been in a corrective mode for a little less than a year, seems poised for another selloff as the dollar reaches its breakout level. The US dollar and gold have an inverse relationship as long as panic and inflation have not gripped the markets.

Europe has been looming over the horizon for quite some time, but it has not created a panic in the market yet. Also, with the general slowdown in the global economy, inflation is not on the horizon except in a few emerging countries. If this scenario continues we could see a further selloff in gold on a dollar rally.

Gold, which is down about 19 percent from its peak last year, is still considered to be in a corrective mode…well almost. A 20 percent drop from the peak would put gold in bear market territory. The correction in gold comes after an uninterrupted bull run since 2008.

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[caption id=“attachment_377509” align=“alignleft” width=“380”]  Gold, which is down about 19 percent from its peak last year, is still considered to be in a corrective mode…well almost. AFP[/caption]

However, with the US dollar again trying to break out higher, gold seems poised for a selloff. Let us take a look at the charts of gold ( click here ) and the US dollar index ( click here ) to see what the markets are telling us.

Notice that the dollar index has rallied to its resistance zone once again. Resistance zones are price levels where the supply for an asset far exceeds demand. As a result prices often fall from that level or stagnate. Notice that the dollar index has fallen from its resistance zone twice. In fact, last Thursday the dollar index went above the resistance zone briefly. This shows that buyers of the dollar are taking control over sellers, increasing the likelihood that the greenback will rally higher. However, the index has to close above 83.56 for the rally to happen.

As dollar index rallied to its resistance zone gold sold off to a support zone. Support zones are price levels where the demand for an asset far exceeds supply. As a result prices often rally from that level or stagnate. Notice that gold prices have been hovering near the $1,550 level for quite some time. This signals that support on gold is holding because the resistance on the dollar index is. Once the resistance of the dollar is broken, we could see gold drop too.

The more times a support or resistance level is hit, the greater the chances of it being broken. But the levels are valid till they are broken. A break of the dollar index above the 83.56 level could take the greenback all the way up to the 88.85 area. Gold could then go down to $1,350.

The other thing to take note on the charts is the 30-week simple moving average as shown by the blue line. A moving average displays the average price of an asset class over a specified period of time. When prices are below the moving average and the average is sloping down, the asset carries a bearish bias. That’s now true of gold and the opposite is true of the dollar index.

So should one adopt a strategy of shorting gold and going long on the dollar if the greenback breaks out? Yes, but with some caveats. If there is a sudden panic in the market due to Europe then both the dollar and gold will go up. In case the Federal Reserve announces another monetary easing plan, then the dollar will fall and gold rally.

The market has, of course, taken these scenarios into consideration. Take a close look at the gold chart between the two arrows on the right. You will see that the precious metal has not made a new low, but is making higher lows. A higher low is when the latest low in price is higher than the previous low.

Even though this does not show strength in gold it shows a pause in its weakening. This is despite the fact that the dollar index made a higher high indicating continued strength. So keep the potential euro panic and Federal Reserve easing in mind when shorting gold. And when going long on the dollar keep the possibility of easing in mind. A euro panic will be a positive for the US dollar.

Finally a quick note on India. If the dollar index rallies, in all probability the rupee will fall against the greenback. This may neutralise the effect of gold’s fall in rupee terms.

George Albert is Editor, www.capturetrends.com