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Gold: The Dip Looks Technical and Temporary

Posted
9/3/2013 10:32:00 AM
By: Martin Tillier
Referenced Stocks:GLD

Regular readers will be aware that I can sometimes be dismissive of technical indicators. Some assume that my background in the Foreign Exchange market would lead to me placing exaggerated importance on the technical side of trading and investing, but in fact the opposite is true. What really drives the price of anything in which a market is made is simple supply and demand. The fact that, in the past, a particular pattern has preceded a move in one direction or the other doesn’t logically mean it will happen again. To the extent that it does, it is because people pay attention to those levels.

Fibonacci retracement levels are a great example of this. Fibonacci was a Thirteenth Century mathematician who wrote about a sequence of numbers beginning with zero, one, in which the next number is the sum of the previous two. Thus the sequence goes 0,1,1,2,3,5,8 etc. When these numbers are ‘played with’ certain percentages recur with regularity.

Many believe that when a significant move in price is followed by a retracement, these percentages form natural points of support and resistance. The much talked of 38.2% retracement is one of the more significant ones. To non-mathematicians and to those outside of the trading world, the idea that a 38.2% retracement in price could be significant is, quite frankly, ridiculous.

The fact is, though, that these numbers have become significant. I don’t attribute this to any magic in the number, but if enough people use the level to justify a certain action, so a kind of self-fulfilling prophecy takes shape. When the price of something has dropped and then recovered, it is likely that sellers will emerge when that recovery reaches the 38.2% level.

So it is at the moment with gold, or more accurately the SPDR Gold Shares ETF, GLD. As much as it angers the gold purists, GLD is huge (over $39 Billion) and for many investors is the cheapest and easiest way of investing in gold. There is a degree of ‘chicken and egg’ in that, while GLD is designed to track the price of gold, significant moves in the ETF will sometimes drive the price of the commodity due to its size.

 

The above chart represents the last year in GLD, with the brown line connecting the high (174.07 on October 4th 2012) to the low (114.68 on June 28th 2013). The red line represents a 38.2% retracement of that drop.

As you can see, the recovery in price has stalled at exactly that level. The fact that this level also represents the high reached in a mini-recovery at the end of May has undoubtedly added fuel to the fire, but it is hard to escape the conclusion that the 38.2% retracement level has some significance here.

The question for investors, of course, is what does that tell us about GLD’s recovery? Have we seen a correction come to an end, enabling the fall to resume with added strength or is this just a blip in the retracement? I am more inclined to believe the latter.

It is in the nature of traders who follow things like Fibonacci levels that their positions are short term. They have seen the bounce off the level, so any move back up will see profit taking, adding strength to that move. Should it be strong enough to break through that now significant resistance level around 137.50 and the way will be cleared for a continued price appreciation.

As with all things, fundamental changes will dictate whether or not that happens, but inflation fears and the continued effects of loose monetary policy remain in many parts of the world, so I suspect that upward momentum should resume.

In short, then, if you own GLD or the physical metal I don’t think now is the time to sell. Similarly, consolidation around current levels or any small drop from here represent buying opportunities.

You can take that opinion as you will, but if nothing else, the strength of resistance attributable to what many would see as just a mathematical coincidence indicates the importance of being aware of such levels, even if your logic tells you they cannot be significant. If enough people act in response to something, then it matters, whether you like it or not.