Many Properties, Many Investment Theses
Gold (NYSEARCA:GLD) represents different things to different investors: a commodity, a currency, a store of value, a luxury good, a hedge against inflation. To other investors, gold is an industrial commodity.
With so many different demand drivers, some will note that certain drivers involve consumption, such as for jewelry and industrial applications. For the rest, gold is an investment, and remains available for re-sale.
What Drives Gold Prices?
The scale of the gold derivatives market means that paper transactions drive short term fluctuations in the price of gold more than the fundamentals (i.e. supply and demand for bullion). Supply and demand drive prices in the longer term.
So while physical demand has remained robust in the face of declining gold prices, this has done little to stanch the decline.
With so many types of investors owning gold for different reasons, it's clear that no one group has a monopoly on driving or dictating the price (allegations by certain SA authors regarding conspiracies perpetrated by bullion banks notwithstanding).
The Case for Technical Analysis - Gold Market Psychology
In a market driven more by derivative bets than by supply and demand (in the short-term, at least), we find technical analysis to be a useful tool. Technical analysis has been exceedingly accurate at predicting the timing and scope of gold price increases as well as decline.
Unfortunately, the present chart looks dire: We have evaluated the GLD chart on a technical basis by drawing on top of it the formations we have identified. We have then annotated these formations to explain them to those unfamiliar with technical analysis. The chart indicates a likely decline by a material degree.
If the pattern continues and gold breaks through the $1,180 resistance level (About $114.00 on the GLD ETP), it portends a further decline to as low as $900.
GLD: An Ugly Technical Chart
Early 2013: Rectangles With Downward Breakouts
The chart shows rectangles in Early 2013, where gold bounced about in a range-bound fashion; in both cases prices broke out downward.
A rectangle forms when some group or collective of investors dump gold beyond a certain price. When it declines to a certain lower price, there is some concentration of investors willing to buy; this props up prices at a certain point and creates the base of the rectangle.
If demand is sufficient to break resistance at the top of the rectangle, prices can move higher. If all the support at the bottom of the rectangle is exhausted, prices can break lower. Both times in 2013, gold broke lower.
The second breakout was larger in scope.
The April Drop & Subsequent Descending Triangle
After the April drop, gold began to form a descending triangle; again there was a new support level which caused prices to bounce each time they hit the base of the triangle at about $1,350. Then, all buyers at $1,350 were taken out, and the second drop occurred.
The quantum of the second drop was in line with the downward breakout from the triangle suggested.
Head And Shoulders
Later in the year, gold completed what appeared to be a head and shoulders top. This type of formation, usually found in increasing charts, usually signals the end of a long advance. In an already declining chart, it is a sign of further weakness.
The Big Picture
The most disconcerting element of the technical chart for gold is that the patterns discussed have the effect of combining to form a massive descending triangle formation. Descending triangles have a downward bias; while they can breakout in either direction, the likely scenario is down.
If gold breaks out from the massive descending triangle, it could go as low as $1,000 or even $900.
A Technical Glimmer of Hope
Astute chartists will notice that gold nearly completed a large head and shoulders bottom, although it ended up failing to complete the pattern as it failed to break out in early November 2013. Such a bottom, if completed, would likely have signaled a technical bottoming of gold and a return to in increasing major trend for the commodity.
See the large orange annotations for the failed head and shoulders bottom.
In fact, close inspection will indicate that gold did in fact complete a smaller head and shoulders bottom (see the smaller black text annotations), and this did lead to a significant increase in August.
However, this small Head and Shoulders bottom did not reverse the major trend.
We argue that this successful Head and Shoulders bottom is of limited technical significance because of it's small size and the sharply downward sloping neckline.
However, these failed bottoms do indicate possible exhaustion of the downtrend in gold. So while the chart looks pretty grim overall, there is the prospect of a major trend reversal, after which we would expect a prolonged positive movement. This reversal could come if gold fails to break through the $1,180 resistance line at the base of the descending triangle, and instead breaks out to the upside.
Fundamentals Must Be Considered
Technical analysis is a very useful tool. However, it can't be considered in a vacuum. This author has recently written on the fundamentals of gold, and the rising costs of mining it.
If gold were to breakout downwards on a technical basis and actually reach $900, we would think this is likely to be a fleeting phenomenon, as the costs mining it are in excess of this (All-in sustaining costs are far higher than this, and even cash costs are higher than this for some miners). $900 gold would not be sustainable, as most mining companies would shut down, causing a rapid decline in supply. This would result in a recovery of gold prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.