Gold to Test Critical $295-$300 Benchmark

Gold futures fell out of the proverbial bed on Friday (July 26), falling to a 4-month low just above the psychological $300 mark. Gold prices have been especially hard hit by market forces as the "hard down" phase of the dominant short-term cycle continues into next week. We knew the cycles would be down heading into August, but we did not envision the extent of the present weakness in gold and gold equities.

We were nervous about the price pattern in the daily gold futures chart, which shows that gold's previous price low before Friday (at $306) occurred somewhat to the right of center of a parabolic bowl. This is not an ideal place to bottom since the best bottoms and subsequent rallies nearly always begin by prices bottoming at dead-center of the bowl. Whenever prices bottom to the right of center it usually implies weakness and frequently harbingers a break below the bowl and further erosion of price levels. This fact alone implied great weakness in the gold futures market and indicated a move to lower levels was probable. In order to gain greater perspective into gold's position, we pulled up a monthly chart of gold futures going back 10 years. We were admittedly taken aback at what we saw.

Although the dominant price pattern in gold is that of a parabolic bowl, this bowl that has been responsible for the 30-week upward move since the beginning of the year is on the verge of being broken. More importantly, the nearly six-year downward trend stretching all the way back to the highs near $420 in January 1996 and culminating with the late 2001 lows (at which time the downtrend line was broken) was apparently broken without the proper amount of trading volume at the break. Classical technical analysis emphasizes that all downward trend line breaks must occur on high volume in order for the ensuing rally to have substantial upside potential. Major trend line breaks that are not accompanied by high volume frequently retrace nearly all the upside gains before the real rally gets underway. In other words, it is possible that we could have experienced an artificial gold rally from the late 2001 lows to the early June highs.

If we assume that gold prices will continue to fall until all the previous rally has been retraced that would take us back to the breakout point of approximately $280-$285. This level also approximates to the minimum measuring implication of the head and shoulders breakdown in the daily gold futures chart, which projects to around $285-$290. Gold is within kissing distance of its critical $300 benchmark floor, so a break below this level would all but guarantee a move down to the lower levels around $285. Another point worth considering is that the long-term gold monthly chart shows two of three trend lines have already been established in a classic "fan line" retracement. It is very common for major declines to bottom in this fashion, and it nearly always takes time for strong bottoms to be thoroughly established before the next sustained rising trend can get underway. Therefore we should not be surprised if gold continues an overall sideways trading range between $280 or $285-$320 for the next few months. The one hope gold has for remaining in an overall strong technical position from which to launch another leg of rally is to bottom above $300 and then break out above the immediate overhead resistance around $320.

Now look at the daily chart for October Gold futures. A modified head and shoulders top between late April and late July was violated at the neckline on Thursday-Friday (July 25-26). A follow-through on the downside would in all likelihood bring gold to a quick test of that super critical $300 benchmark, which also happens to be the final rising trend line area for the current year. So you can see just how critical this area is to gold's technical outlook. The downside measuring implications of the H&S pattern in the daily chart project down to around $295, or the March lows. So even if gold briefly penetrated $300 yet found support above $295 all hope would not be lost. But there must be solid support between this $295-$300 area in order for gold to have any chance of staying alive.

Breaking below $300 this week would be quite bearish for gold as it would mean the 6-year parabolic bowl in the monthly chart has been violated. When bowls are broken it nearly always leads to a significant price decline. Granted, this hasn't happened yet and it may not for all we know. This is not meant to sound alarmist, but forewarned is fore-armed. We must prepare for all possibilities in this market.