Gold's $30 drop: overreaction or sign of things to come?

Today saw gold turn sharply lower, partially in response to a rebounding European stock market. In other words, the safe haven asset has lost out in favour of the riskier stocks. What’s more, the dollar has risen once again today and this has weighed on some buck-denominated commodities, including precious metals and crude oil with WTI dropping to a fresh multi-year low sub-$44 a barrel. Meanwhile as the CFTC reported on Friday, bullish speculation has increased noticeably in recent weeks. In the week to 20 January, net long positions had increased by a further 27,400 to 129,300 contracts, putting them at their highest level since July 2014. As a result, gold had built up a good correction potential which is probably what we are seeing now. The CFTC’s data for the week to this Tuesday 27 January will be published after the markets close on Friday evening. It will probably show another increase in bullish speculation as the data will not reflect what has happened since Tuesday. Gold thus remains in danger of falling further as speculators rush to abandon their bullish positions. That said, the metal is now hovering around a key technical area which may limit the falls.

Technical outlook

As we reported last Tuesday, gold was indeed ‘running on empty’ when it traded around the $1300 mark. It has dropped quite noticeably from that area, most dramatically in today’s session after it fell below the key $1272 support level. The break of this key level must have triggered some stop sell orders today, helping to accelerate the pace of the selling. In fact, the most significant technical development was when the metal failed to hold its own above the 61.8% Fibonacci retracement level of the last downswing at $1292/3 at the start of this week. For whatever reason, gold traders highly respect the 61.8% Fibonacci level and this is yet another example of this. Now, where can we expect gold to bounce back from? Well, one level is being tested as we go to press, namely $1252/55. As can be seen from the chart, this level was formerly resistance and it also marks the 200-day moving average. If the buyers step in here, then gold could bounce back towards that broken support at $1272, a level which could potentially then turn into resistance. The next support is around $1240, which, as well as prior resistance-turned-support, corresponds with the 38.2% Fibonacci retracement level of the last upswing. Meanwhile a decisive break below $1240 and the next stop could be $1198/1200 – the 61.8% Fibonacci level. Traders may also want to keep an eye on the RSI, which is now trending lower after drifting into the overbought threshold (>70) a few days ago. As can be seen in the sub chart, it is testing its own support trend around 52. If it goes on to break this trend and fall below 40 then gold may follow suit and break some of the above-mentioned support levels. But let’s not jump to any conclusions here, for after all, gold has already broken a long-term bearish trend line and is currently holding above the 200-day average.

Figure 1:

Source: FOREX.com.