Gold (NYSEARCA:GLD) has been a great investment over the last decade. However, for almost a year now, gold has not perform so well, and it remains unclear if it is worth buying or not. The first chart below shows the evolution of the price of gold over the last four years. As we can see, we had a nice up trending channel that started in September 2008 and that was broken to the upside in August 2011. This channel breakout was related to the debt ceiling debate and the consequent rating downgrade.
It was a moment of euphoria for gold owners: the sky was the limit. But then, in September 2011, the Fed decided to do Operation Twist instead of expanding its balance sheet and this brought us back to the original up trending channel. Finally in May of this year, we broke the lower edge of this channel as indicated by the red arrow on the graph. This was synced with the results of the Greek elections. But in reality it was a sign that we were entering into a critical phase of the European debt crisis.
Figure 1. Gold spot price weekly time frame.
When we look closer at the chart of gold as shown on figure 2, we see that we have a clear descending triangle pattern formed by the bottom support at $1530 and the descending trend lines from the peaks at ~$1900. This death triangle tells us one thing: a serious event will soon happen. We are very close to the edge of the cliff, and the downside or upside breakout of this pattern is now a matter of days, maximum a couple of weeks.
Figure 2. Gold spot price daily time frame.
So the technicals of gold point to an important cross road for this currency-commodity. What direction is more likely? For that, we need to discuss the fundamentals. Last week we had an important FOMC meeting which ended up providing only an extension till the end of this year of Operation Twist. This decision confirmed the bullish momentum for the dollar. This decision has also directly impacted gold, and we lost around $60 during last week's trading. But the most important remains ahead of us. Next week, on June 28th and 29th we have the quarterly European council meeting. The European sovereign crisis has now entered a new stage, possibly the final one.
In this stage, Italy and Spain are tethering on the edge of a runaway of their debt. This is why the outcome of this meeting is very much awaited by market participants. If major decisions are taken, this could be a very bullish signal for the eurozone, the euro, and gold. And we could break out of this descending triangle to the upside. However, the more likely outcome is another round of half measures as we have been accustomed to. This would be bearish of course. This time, however, the downside move could be far stronger than the previous times. Even Mario Monti has honestly described this meeting as a make or break event for the euro.
As a result, we might witness a massive shift away from the eurozone into the dollar and dollar based assets. And as a side effect, it would greatly impact gold prices to the downside. Last year, we suggested several scenarios on the final outcome of the European sovereign crisis. We still think that the more likely final outcome is an exit of Germany. The divergence between the southern countries that are ready to go now into deeper integration because they cannot wait any further and the northern countries that do not want to share the debt burden is now reaching a climax. The epilogue is near.
Apart from Europe and the Fed, other signs favor a breakout to the downside for gold: the Chinese economic slowdown and the Indian rupee devaluation will certainly reduce the purchasing power of the middle class in these societies. This will weaken demand for gold jewelry and therefore affect the buying support of gold.
As a conclusion, we expect gold to breach its $1530 key support level in the very near term. Since there are many stop loss orders just below $1530, we shall witness a fast acceleration to the downside if this happens. A weekly closure below $1530 will be a strong signal that the sellers are in control. We would strongly recommend our bullish readers not to enter long during the first weeks if a break out to the downside would occur, since we might go very far below $1530. Some key support levels where a reversal might occur are $1440, $1300 and $1150.
Although less likely, we also remain open to an upside scenario that could manifest itself by a weekly closure above $1650. We recommend using options around the 28th-29th June with distant strike prices and at least a few days of expiry time to have a low risk / high reward earning opportunity. Otherwise, following the trend after the outcome of the European summit might be also highly beneficial.
Disclosure: I have no positions in any stocks mentioned, but may initiate a short position in GLD over the next 72 hours.