Don't count gold out: it may be about to bounce back

Gold, which has been in a steady downtrend, finally crashed into a support zone, increasing the potential of a rally. Gold has been confusing a lot of traders recently as the spigot of money opened by the central banks has not pushed up the price of this precious metal.

Yesterday, when gold crashed to its support zone, a lot of commentators said the power of gold is over. Let’s wait and see if the kids of yesterday are right when they write off the over 4,000-year-old currency. Support zones are price levels were demand exceeds supply leading to a rally in price.

Let us first look at the chart of gold (refer to chart below). This is the weekly chart of gold. Notice that gold has come down to a gap area from where it a parabolic run-up . The gap shown by the arrow is the spot from where the precious metal moved from a steady uptrend to a parabolic one.

Now, with prices back at that level, one could except a bounce or even a reversal. Let us look further and apply some indicators to price. The three curving lines seen on the chart are Bollinger Bands. Bollinger Bands is a tool invented by John Bollinger and is used to measure the “highness” or “lowness” of the price relative to previous trades. The tool actually shows where the price is within a trading band. When prices fall too low they bounce back up to the middle of the channel and vice versa when they rally too high.

A look at the chart will show that the price of gold, measured by the largest gold exchange traded fund (GLD), went outside the Bollinger band on the downside. This increases the likelihood of a bounce. Then let us look at the commodity channel index (CCI). Notice that even though the price of gold has fallen and made a new low, the CCI has not. This is called positive divergence, which indicates a possible bounce in price.

So we have three factors working in favour of gold bulls. First is the fact that price is below the lower Bollinger Band; second is the positive divergence; and the most important point is that gold is at support. The only disadvantage for bulls is that the price stayed a little above the support zone for some time before falling. This creates resistance on the way up.

Gold’s fall has confounded many. Usually, when central banks print money, the price of gold rises. However, that has stopped happening for some time now. You see the link between gold and easy money is not that direct. If the printing of money leads to inflation, then the price of gold will shoot up. Also, fear in the market leads to a rally in gold. Today global economies are not seeing inflation and there is a lot of complacency in the markets. The result is that the price of the yellow metal has been languishing. It is also possible that the gold markets feel that a recession might be in the offing, due to which the price of the precious metal is falling.

Nifty: Even though the Nifty has sold off strongly, it is being helped up by support, which is the gap. The gaps are shown by the white arrows (refer chart below). If one gap is broken, the price can go to the next. It is very possible that the index could fill the gap and then rally some. But from the looks of it the index seems to be headed to the lower gap level. At this point we’d not short the Nifty as its in a demand zone. Aggressive traders can go long or wait for the gap to fill and go long with a stop below the gap level. Shorts should wait for the index to rally before going short. The index at 5,745 is a decent level to short with a stop above 5,765.

George Albert is Editor, www.capturetrends.com