Technicals: Gold catches bounce; decline is no big deal

Gold caught a bounce this week as it hit a support zone driven by sell recommendations by leading investment firms. It has now formed a bullish dragon fly which could erase at least last week’s fall over the next few trading sessions.

Nifty on the other hand was unable to break the gap support we had mentioned in last week’s article and bounced strongly. Support levels are zones where the demand for stock far exceeds supply, leading to a rally in price. A gap is an area of extreme demand-supply imbalance due to which the price after closing at one level opens much higher the next trading day. When the price comes back to that level, it often has a parabolic reversal. This is what happened to Nifty last week.

[caption id=“attachment_715454” align=“alignleft” width=“380”] Gold is considered a long-term investment which went into bear territory with a 30% correction this week. AFP[/caption]

First let’s take a look at gold. (See chart above). In last week’s article we had mentioned that gold is highly likely to bounce as it had fallen to a support zone and moved out of the Bollinger Band. However, that did not happen as gold broke through the support level and then fell lower. A lot of people had invested in gold and panicked when they saw a huge drop in price on Friday of last week. Then when the market opened on Monday many investors wanted to get out leading to gap down. Once all the sellers were out of their positions, gold began rising.

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Looking at the Bollinger bands now and you’ll notice that the price is still out of the band. The Bollinger bands are shown by the curving lines. Typically in a downtrend, price moves between the lower line and the middle line. Very rarely does price stay outside the band for a long time. Given these historical factors, gold has a high potential to rise and come back into the band and possibly hit the mid line. As of writing this report, the price of GLD, the exchange traded fund that tracks gold, is at $139.47, the lower Bollinger line is at $142.43 and the middle line is at 156.43.

Now these lines will fall in future as past higher prices will no longer be part of calculating the Bollinger Bands and the newer, lower prices gain more weight. So one may not see a rise of gold to $156 level, but a rise is highly likely. However, if the support zone near the $130 level is broken, we could see price go all the way down the next support level around $115.

So were we wrong on gold? One must always keep in mind that there is no right or wrong in the market. The market is all about probabilities. When had mentioned in last week’s article that since the broken support zone was touched a few times earlier a rally might not be possible. That’s the probability that worked.

Like we said last week the fall in gold could also be portending a slowdown. When there is inflation the price of gold goes up so in real terms gold protects your purchasing power. Also when there is slowdown or recession a fall in the price of gold is not necessarily loss but the mere fact that the precious metal is maintaining price parity with economic conditions.

Of course it would have been better to be in paper money as one could have bought more gold when its prices fell. But gold is considered a long-term investment which went into bear territory with a 30% correction this week. So one typically does not time gold as over the long term gold has always won.

Also let us put the recent fall in historic perspective and you’ll realize that this drop is not really a big deal. In 2008 when the recession started, gold dropped 31% in 31 weeks and then went to all-time highs. Now gold fell about 30% in 84 weeks from its September 2011 levels.

So this fall is much slower than the 2008 fall.

Now let us look at the Nifty chart.

[caption id=“attachment_715452” align=“alignleft” width=“842”] The gaps on the chart are pointed out by white arrows.[/caption]

In last week’s article we had mentioned Nifty is in a gap support area and that aggressive traders could go long with a stop below the gap. The gaps on the chart are pointed out by white arrows. The index did rally and we mentioned it could stop and reverse at the 5750 level. Nifty only paused there for a day and then rallied out again. The next resistance zone for the index is shown by the red horizontal lines.