Gold Decline Imminent: Why I Recommend Buying on the Dips

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Includes: DGL, GLD, IAU
by: NewstraderFX

Summary: While the bull market that began in February of 2001 is intact, a decline to the $1260 area could be seen over the next few weeks.

During gold’s ten-year run, the largest percentage decline (34%) began on March 17 2008, 9 days after Bear Sterns disappeared, and lasted until October 24, 2008, about 5 weeks after Lehman Brothers went bankrupt. The point here is that given there exists a 10 year rally (or trend), it is very unlikely to see a decline of this magnitude again absent some sort of financial (or other) crisis. And since another disaster does not appear to be in the offing at the present time, we have to believe the overall direction for gold remains to the upside.

Before proceeding, for those who disagree about whether another crisis is at hand, I have always been of the opinion that the sovereign debt issues in Europe will not cause a repeat of anything resembling 2008. But when you come right down to it was even a situation as bad as 2008 the end of the world? Well then, neither will be the issues facing Europe at this time. Things will slog on. Greece, Ireland, et. al. will become chapters in a book on economic history.

That being said, there certainly is nothing unusual in seeing trends periodically retrace and I believe what we seeing now with gold is simply one of those episodes. As a trader, my goal is to find price levels where I can take the least amount of risk and have the largest potential for reward, which i do by following my overall philosophy of buying on the dips,

I first warned about gold back on November 12. Since then, the yellow metal declined to $1329.44 and made a new high on $1431.03. The important support on $1336.30 was broken two weeks ago and with that, a move to test the $1326 area seems to be all but inevitable sometime over the next few days.

As seen on the chart, I’m using a Fibonacci study to measure retracement levels of the most recent, sustained up swing, which began last July 28. What also is shown is how well the 23.6 and 38.2 levels acted as strong support, with the later being especially important because of the numerous tests between Oct. 19 and Nov. 16. And while it is difficult to say whether support will again be found in the $1326 area, that isn't the point. I still want to be a buyer there because:

  1. My overall bias is bullish unless disaster ocurrs
  2. A strong reward to risk ratio exists since my stop can be tight while the upside potential is to at least the previous high on $1431. Placing a stop for this trade at around $1319, which is what I will do because I don't need to hold it too far below the fib, provides a better than a 17:1 reward/risk ratio.

With that being said, a close below the 38.2 retrace level would imply that an eventual decline to the 61.8 retracement level on $1261.52 could take place. And if that happens, an entry there provides an even better potential since I would still have the same target.

Click to enlarge

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I am looking for a long entry as mentioned