Gold is the selling overdone

From its opening price of about $1145 today, gold has dropped almost $30 to a low so far of $1117. It has therefore shed its entire gains made since the beginning of the US stock market meltdown on Wednesday of last week. On the one hand, gold’s counter-intuitive price action this week strongly suggests that the metal is heading to significantly lower levels. After all, the 1000 point drop in the Dow Jones Industrial Average on Monday and the extremely high stock market volatility since then ‘should’ have boosted the appeal of gold like the other safe haven assets. On the other hand however the metal has been weighed down by a corresponding bounce in the dollar over the past couple of days.

It is therefore still early days and traders should not form a strong conviction about gold’s near-term direction. Indeed, if the stock markets sharply extend their declines then so too may the US dollar as expectations over a Fed rate hike gets pushed further out. This potential scenario is likely to help underpin the precious metal. In fact, the Fed’s William Dudley today has said that the argument for increasing rates in September “seem less compelling” to him than “a few weeks ago.” Though the Fed was almost certain not raise rates next month anyway, Dudley’s comments will undoubtedly be interpreted as dovish and will raise questions marks over a 2015 hike.

But as things stand, the precious metal certainly appears to be on a shaky footing. Bullish speculators will have been very disappointed that the metal has been unable to benefit from the stock market turmoil this week and are thus becoming less optimistic about a potential rally. The bears will be happy that the $1165/70 resistance area has been defended successfully. As a reminder, the $1165/70 area marked the convergence of the 100-day moving average with a medium-term bearish trend line and the 38.2% Fibonacci retracement of the downswing from the 2015 high that was achieved in January at $1307.

As a result of the sell-off, gold has broken several key supports including $1145 and $1135, levels that may now turn into resistance. At the time of this writing, gold was testing the next support level around $1120. The next potential support could be the 61.8% Fibonacci retracement level of the recent up move at $1112/3. The bulls will not only want to see these levels hold as support but need gold to go on and break that $1165/70 resistance area. If seen, this would be a very bullish development. That’s because it would also confirm the break out from a potential falling wedge bullish pattern.

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