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Is The Recent Gold And Silver Breakdown Signal Still Valid?

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This article is more than 9 years old.

On Sunday, I wrote a piece in which I showed two potentially bearish longer-term "pennant" patterns in gold and silver that could lead to serious declines provided that gold and silver do not reverse their recent technical breakdowns below $1,200 and $19 respectively. In keeping with the erratic, low-volume trading conditions that are common around the holidays, gold and silver plunged on Sunday night (U.S. time) after Switzerland voted "no" for the gold referendum, only to spike on Monday morning after Japan's credit rating downgrade and because of crude oil's bounce after its 10 percent Friday sell-off.

Gold is currently trading at $1,207.70 and silver is trading at $16.42. Does today's move invalidate gold and silver's recent technical breakdowns? To answer this question, we need to take a look at the charts. The $1,200 level in gold that I've been discussing for a while is certainly not an arbitrary number as it represents a key psychological "floor" or support level that dates back to mid-2013. Many other analysts and traders are watching this level as well because a serious break below it is likely a sign that another wave of gold's sell-off is about to begin. A failure to break below this level, on the other hand, is likely to foreshadow a bounce or rally.

Source: Finviz.com

Of course, nothing in the markets is as simple as just watching for a break above or below a round number that so many other people are watching; no, the markets always do their best to actually make us work for our money. As you can see from the short-term gold chart below, the yellow metal has chopped above and below $1,200 several times in the past year, "head-faking" traders who try to play the breakouts or breakdowns.

In order to avoid getting caught up in the head-fakes that seem to be endemic at gold's $1,200 level, it may be useful to look at secondary support or resistance levels for added confirmation of the next big move. On the downside, $1,130 (the November low) is the next most important support level to watch if gold breaks below $1,200 again. On the upside, a solid close above the $1,250 resistance level (the October high) would provide added confirmation that gold's rally is for real and not just another head-fake.

Source: Finviz.com

Silver is still below its key $19 resistance level that marked the metal's lows for much of the last two years. A significant and convincing break above this level would negate the recent bearish signals. Silver follows gold very closely, so if gold eventually experiences a genuine breakdown under $1,200 and $1,130, silver would likely be following right behind it.

Source: Finviz.com

In my Sunday piece, I discussed a fairly extreme scenario in which gold drops significantly below $1,000 and silver significantly below $10. Can that happen? Certainly. But it's important to realize what it will take for this scenario to play out. As I discussed, it will most likely require a very powerful bull market in the U.S. dollar against other major currencies. I showed the $90-$93 resistance zone in the U.S. Dollar Index as a "line in the sand" to help determine if the dollar was about to embark on such a bull market.

Source: Barchart.com 

What could cause a powerful dollar surge? I can think of four main scenarios:

1) A violent unwinding of the multi-trillion dollar global carry trade that arose after the Financial Crisis as a byproduct of the Federal Reserve's ZIRP and QE policies. This massive carry trade helped to inflate asset bubbles across the planet, as I discussed at the beginning of each of my emerging markets bubble reports. When the carry trade ultimately unwinds and the global "carry trade bubble" pops, the sudden demand for U.S. dollars could easily lead to a significant bull market.

2) This point relates closely to the one above. The ending of ZIRP or zero interest rate policy in the United States as the Fed moves toward tighter monetary policy in the next few years, which is likely to be supportive of the dollar.

3) Japan is unable to escape its economic stagnation (due to excessive debt and demographic decline), which causes Bank of Japan to become even more aggressive with its monetary stimulus programs. This outcome would likely lead to an even sharper decline in the yen and concomitant upward pressure on the U.S. dollar.

4) Europe continues to follow Japan down the "Lost Decade" path (due to excessive debt and demographic decline, like Japan), which pushes the ECB toward aggressive monetary stimulus programs that weaken the euro and boost the U.S. dollar.

The U.S. dollar bull market (and extreme gold and silver bear market) scenarios discussed above pertain to the intermediate and longer-term future and are unlikely to happen next week or even in a couple of months. Still, they are plausible enough to keep in mind over the next couple of years.

In the shorter-term, however, the U.S. Dollar Index chart shown below is more relevant as an indicator for confirming gold and silver's recent moves. At the moment, the index is trading in a range between its 87 support level/rising uptrend line and the 88.50 resistance level. A Dollar Index breakout could lead to further gains and precious metals weakness, while a breakdown below those supports should have the opposite implications. For now, the U.S. dollar has not confirmed today's rally in precious metals.

Source: Finviz.com

To summarize, I would not want to be shorting precious metals now that gold is above $1,200. If gold breaks below $1,200 once again and can also break decisively below its $1,130 support, I will revisit the bearish thesis that I discussed on Sunday. For now, consider me as having a neutral position on gold and silver until the picture clears up a bit more.

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(Disclaimer: All information is provided for educational purposes only and should not be relied on for making any investment decisions. These chart analysis blog posts are simply market “play by plays” and color commentaries, not hard predictions, as the author is an agnostic on short-term market movements.)