An Objective Look at Gold Support Levels

01/26/2010 12:01 am EST

Focus: COMMODITIES

The December 2009 high in gold was projected by various market technicians to coincide with the $1,200 price level (based on a variety of cyclical, Fibonacci, and resistance studies), and once it headed south, it did so with little hesitation, dropping down to $1,075 in only three weeks.

The bear market rally that ensued was bullish enough to cause the faithful to believe that this was nothing more than a standard pullback against an intact uptrend, but nothing could be farther from the truth. In fact, basic cycle analysis confirms that gold is likely destined to fall at least another $50 to $100 (if not more) before it hits support levels strong enough to engender another round of base building. Let's have a look at the monthly chart of gold now (Figure 1).


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The strong downward thrust in gold's monthly cycle suggests that a move down to $1,025—the Fibonacci 50% support level—is very probable.

At present, monthly gold (continuous contract) is resting right at the Fibonacci 23.4% support level (calculated from the October 2008 to December 2009 upthrust), and as anyone familiar with trend reversal dynamics already knows, that particular Fibonacci retracement level is usually just a temporary stopping-off point before continuing with a move down to the Fibonacci 38% or 50% retracement levels.

The main reason this appears to be what will come to pass is the current state of the DBS10 cycle oscillator (blue oscillator at bottom of chart). It's in "hard-down" mode, with plenty of room to run before it reaches oversold readings. Given the high reliability of this oscillator to follow through, it appears that shorting gold here and anticipating a move down to at least the Fibonacci 38% level at $1,025 is a reasonably sane course of action. Just below that level is the March 2008 high at $1,014, an area of support that will be a line in the sand as far as determining the health of the long-term uptrend in gold goes.

Now let's check out the daily chart of gold, noting other coincident support levels that might also help establish a rational price target for those already short gold and/or for those ready to take the plunge.

NEXT: Latest Analysis of Daily Gold Chart

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FIGURE 2: GOLD, DAILY. If December's low of $1,075 is taken out, $1,067 is the next Fibonacci support zone, followed by various supports near $1,030, $1,025, $1,014, and $1,010.

The daily Fibonacci levels (not shown here) tell a similar story. The 50% Fibonacci support comes in at $1,067, the 62% Fibonacci resides at $1,030, and the 200-day exponential moving average (EMA; see red line) sits near $1,010. With daily gold having made another convincing close beneath its 50-day EMA (yellow line on chart), there appears to be little support now other than the December swing low at $1,075 (see ellipse).

If this low is taken out, expect another wave of selling that should make the trip down to $1,067 in record time. Every tick in the gold market (0.10) is worth $10, so this could be a way to pick up about $700 in a session or two if the selloff proceeds as anticipated. For those selling near $1,095 (the price of April 2010 gold as I write this), a drop to that first daily Fibonacci level would mean about $2,800 in pretax profits. If you use the 50-day EMA (near $1,114.50) as your stop-loss, your initial risk on the trade would be about $950 and the profit target would be almost three times that at $2,800.

Given the powerful downward pressure in the gold market, finding a trade setup with a risk-reward ratio of 3:1 is a wonderful thing, especially since the monthly cycle is likely to move substantially lower.

More conservative traders can configure the same basic trade using GLD or with mini gold futures contracts. Run a three-bar trailing stop off the daily highs until the $1,067 to $1,070 area approaches and then close the trade down for a profit, especially if trading the full-sized COMEX gold futures (GCJ10) contracts. The February 2010 contract has much more liquidity than the April contract and should be the contract of choice.

This looks like a relatively low-risk trade, one that has plenty of technical and fundamental advantages in its favor. If your margin account can handle the action, this could be a memorable and potentially profitable daily trade setup.

Bottom line, there is little to hold gold up on the way down to the daily Fibonacci 50% retracement level near $1,067, especially if the December low at $1,075 is taken out on a daily close. Beneath that price zone, various Fibonacci chart and EMA support spans the range from $1,030 to $1,010, with the March 2008 swing high at $1,014 being of major importance in the overall scheme of things. Keep a close eye on price action, should it get that low, because there should be volatile (and probably tradable) moves in either direction if it arrives there.

By Donald W. Pendergast Jr. of ChartW59.com

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