Gold and Silver: How Low Will They Go?

01/27/2011 1:27 pm EST

Focus: COMMODITIES

Thomas Aspray

, Professional Trader & Analyst

Last week's daily chart feature "Gold and Silver Will Correct Further" preceded a sharply lower opening and a significant decline in both gold and silver. Early in 2011, there were signs that the precious metals were likely to drop, as the sharp downside reversal on January 4 was significant, in my view.

The explosion of new interest in the precious metals last year had me concerned because I felt that many new investors and traders were not prepared for the volatility of the precious metals. Now that the metals are correcting, my article "Are You Ready for Gold's Volatility?" may give you some additional insight. With the Comex April gold futures contract now 7% below its recent highs, I wanted to take an in-depth technical look at the precious metals and try to identify the important support levels for silver and gold.

Figure 1


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My first step in determining a market's major trend is to look at the monthly charts before moving on to the weekly and then the daily charts. In analyzing the volume patterns, I have found the on-balance volume (OBV), developed by Joseph Granville, to be a very valuable tool. The OBV is plotted in red on the bottom half of the chart, and I have overlaid a 21-period front-end weighted moving average (WMA) in green. The arrows on the OBV identify the successive highs in volume, as each new price high for gold was confirmed by a new high in the OBV. This has kept my major trend analysis positive. The December 2010 highs were also confirmed by the OBV, so the major trend for gold has not changed. The monthly uptrend (line a) is now at $1295 with the 23.6% support from the October 2008 lows at $1254. The more important 38.2% support level is at $1142.
 

Figure 2


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For some time now, I have had Fibonacci price targets at $1352 and $1407, and they both were exceeded on the recent rally. The four-week slide in gold prices looks much more severe on the weekly chart as the weekly uptrend has been reached. The 38.2% support level from the early 2010 lows comes in at $1284 with the 50% support level at $1242. The weekly OBV formed a negative divergence at the December and January highs (line b). The OBV has broken its initial uptrend, line c, and is well below its now declining WMA. This typically is consistent with a correction that will last weeks, not days. There is more important support for the OBV at line d. If we get a bounce in gold over the next few weeks, which is likely, look for the OBV to rally back to its declining WMA.

NEXT: Latest Analysis for Popular Gold ETF GLD

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Figure 3


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The weekly chart of the SPDR Gold Trust (GLD) shows that the OBV also works quite well on liquid ETFs. The uptrend in the OBV (line b) was tested last August before the OBV moved back above its weighted moving average, generating a positive signal. The OBV analysis started to deteriorate over the past two months, diverging from prices as noted on the chart. The drop in the OBV below its weighted moving average the week of December 18 was followed by a rebound back to its WMA. This was a negative development and the uptrend in the OBV was subsequently broken. The OBV could eventually test the lows from last summer. There is first good weekly chart support for GLD now at $123.56, which corresponds to the June 2010 highs, while the 38.2% support from the 2008 lows stands at $112. Using the daily charts, we can better identify the key support levels to monitor.

Figure 4


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For both the Comex April gold contract and GLD, we can identify areas where the Fibonacci support zones converge. Of course, once we get a decent bounce, it will provide us with additional information that can be used to fine-tune the Fibonacci analysis. For April gold, the 38.2% support from the early-2010 low and the 50% support using the rally from the 2010 summer lows is at $1290-$1300, which is the first likely downside target. The next good zone of support is at $1269, which is the minor 61.8% support, and then at $1248, which is the 50% support from the 2010 lows. This is the most likely downside target for the current correction. The longer-term retracement support from the 2008 lows (see Fig. 1) is at $1150.

GLD has already reached the 38.2% support level (in red) at $129.40, which was calculated from the July 2010 lows, and GLD may rebound from this level. The 50% support is at $126.40, while the 38.2% support calculated from the early-2010 low is at $125.40. Therefore, the $125.40-$126.40 area is a good first downside target. Before the correction is over, I would not be surprised to see a drop to the $123.20- $121 area. This corresponds to the short-term 61.8% support and the longer-term 50% support level. 

NEXT: Latest on Silver ETF SLV and Gold Miners ETF GDX

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Figure 5


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The iShares Silver Trust (SLV) has also been hit hard since it reached a high of $30.44 on January 3. As of the close on January 25, it is down almost 14% and has now reached first support at $26. The 23.6% support from the 2008 lows is at $25.20 with the 38.2% support at $22. There is chart support from the 2008 high at $20.73, which coincides with the 50% support level at $19.50. The long-term uptrend, line a, is currently in the $19 area. The weekly OBV did form a short-term negative divergence at the highs, line b, and this was confirmed by the break of the OBV below its weighted moving average. The OBV is now well below its weighted moving average, and this increases the likelihood of a bounce. This is also consistent with the daily technical studies (not shown), which are oversold. SLV has strong resistance in the $27.80-$28.40 area where a rally is likely to stall. The most likely downside target, in my opinion, is the $22-$20.73 area.

Figure 6


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What about the gold mining stocks? The Market Vectors Gold Miners ETF (GDX) just recently violated its steep uptrend (line b) from the 2008 lows and is already back to good support in the $52 area. The shallower uptrend, line a, is now just above $50 with the 38.2% retracement support from the 2008 lows now at $46.70. The key 50% support lies at $40 with important chart support from the 2010 lows at $39.48. The OBV formed a slight negative divergence at the early-December highs before dropping sharply below both its WMA and the uptrend, line c. On an oversold bounce, there is first resistance for GDX at $57 with stronger resistance at $58.50. I would look for GDX to eventually test the $45-$46.70 area, though it may have a shallower correction than GLD. From the 2008 lows through the close on January 21, GDX is up $240% versus 98.5% for GLD. From the 2010 summer lows, the performance has been pretty even, with GDX up 15.3% versus 15.9% for GLD.

So what would change my view? Any good trader or technician should have an idea of what it would take to change their current analysis. When you are establishing a position, this is represented by a stop, but when you are trying to determine corrective targets in order to take action, it is a bit different. Using the ETFs, which are more widely followed, a close in GLD above $136.30 on volume of over 30 million shares would be a sign that the correction was over. For SLV, it would take a close above $29.05, and for GDX, it would require a close above $61.20 and high volume on both to confirm the price action. Of course, I would expect that before the ETFs reach these levels, there would be some signs from the technical studies that things had changed. As I did during the late 2009 and early 2010 correction, I will update the analysis regularly in the Charts in Play section.

Tom Aspray, professional trader and analyst, serves as senior editor for MoneyShow.com. The views expressed here are his own.

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