Gold hasn't quite bottomed yet

International troubles help the dollar but not the precious metal.

By InvestorPlace Jun 1, 2012 12:27PM

Image: Small Stack of gold ingots (© Anthony Bradshaw/Photographer)By James Brumley

If you think stocks had it rough in May, then you weren't invested in commodities. If you had been, you'd know all too well that everything from coal to sugar to coffee to oil was just hammered, with most commodities posting their biggest full-month losses since October 2008. The CRB Index gave up 10.8% of its value last month.

And no, contrary to assumptions that it's bulletproof, gold didn't escape the commodity meltdown. The world's most precious metal became 6% less precious in May and now is down 19% from its peak price of $1,916 per ounce reached in September.

For gold bugs and newly converted gold maniacs, the recent pullback begs two questions: Why? And where does the bleeding stop?


A couple of explanations can be offered for the current downtrend in gold prices. Both are chipping away, though one more than the other.

The most popular cause is weakening demand for gold, particularly from China and India -- two nations that were gobbling gold up like candy as each waded further into their eras of consumerism. With both countries hitting the proverbial economic wall within the past few weeks, jewelry became a lot less important, real fast.

Oh, it's still a relative matter. India's GDP growth was "only" 6.5% for the 2011 to 2012 year. That's the weakest growth in nine years, however, so it's being viewed in a negative light. China's story is a similar one.

The less-recognized -- though more significant -- reason gold is under attack is happening a little west of India and China, in Europe. Perhaps you've heard? The eurozone is experiencing a wee bit o' economic trouble, and it's absolutely killing most of their currencies.

What's that got to do with gold? Gold is priced in American dollars. When currencies other than U.S. dollars lose their value, then U.S. greenbacks increase in value -- relatively. Thing is, when the dollar is worth more, it (generally) makes each ounce of gold worth less, in terms of price.

That's a simplified explanation, but at the core, it's an accurate one. And if you don't believe me, just take a look at the chart above, which compares the dollar's value against gold for the past several years. They move in opposite directions. If the dollar is going to continue rallying, gold is going to remain under pressure.

Where does the bleeding stop?

While the cause is interesting, it doesn't entirely matter to traders. What matters to traders is simply that gold futures are falling. Or, if you're not a futures trader, what might matter to you is that the SPDR Gold Trust (GLD) is sinking. Either way, gold is sinking. There are some key price points we can use as make-or-break support and resistance, however.

For gold futures, there's a big line in the sand at $1,441. It should act as support and rekindle the bigger rally, but if it fails to hold as a floor, look out below -- things could go from bad to worse in a hurry. (Disclosure: I’m expecting a bounce there.) If the number rings a bell, it might be because yours truly predicted back in December that gold ultimately would slump to that level. It wasn't a well-received outlook at the time; vindication can be sweet.

The $1,441 level wasn't just pulled out of a hat. It's a 38.2% Fibonacci retracement line. No, Fibonacci line analysis is hardly a mainstream technique, even by technical trading standards. It works more often than not, however, and considering there's no other meaningful floor around now that gold has broken under a long-term support line, Fibonacci lines are providing a framework the market so desperately needs. Of course, a minor support line has developed at $1,522, so there's a smidgen of a chance the gold bulls could regroup here and just skip the full-blown Fibonacci retest.

If you're more of an exchange-traded fund enthusiast, then know that the SPDR Gold Trust will find its 38.2% retracement line at $140. GLD's near-term support level is $148, and like gold, we'll give the fund the benefit of the doubt until we see traded under that floor. If it fails, look for a retest of the $140 mark, at least.

Bottom line

Just a few months ago, few ever would have thought gold could hit a wall as hard as it has. There's a lesson in the fact that it did, though -- when the consensus is that unanimous, and the certainty of the opinions forming that consensus is so strong, that's the time to start taking a contrarian stance.

Ironically, gold won't hit a bottom until most of the traders are sure it never can go up again. Reaching the $1,441 level should pretty much do the trick.

As of this writing, James Brumley did not hold a position in any of the aforementioned securities.

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