Imagine a bullet fired at the sky.
It climbs higher and higher until gravity overcomes its upward momentum. The bullet begins to fall.
Now, imagine small wings on the bullet that flap while it is falling. The wings are just enough to create a series of slight upswings while on the downward trajectory.
Known as "bear flags," this wavelike cycle recurs until the momentum ends and the bullet drops to the ground. Bear flags are thought to signal additional downward moves to come.
This is exactly what has happened with the price of gold since it hit its high near $1,900 per ounce in August 2011. More recently, this action has been exaggerated, with gold trending downward since striking highs in the $1,800 range back in October.
Every investor's worries about government monetary easing and eurozone debt acted as the wings on the coasting bullet, temporarily lifting gold higher, only to have the price drift back into the downtrend.
Finally, this brief upward trend ended this month with gold plunging nearly 30% since its October highs. In just two trading sessions, the price plummeted more than 230 points.
Gold-mining stocks were also battered worldwide. Australia-based Kingsgate Consolidated and Beadell Resources both dove 15%, while China's Zhaojin Mining gave back more than 9%.
Remember, the average cash production price for gold is around $1,200 per ounce. This means the closer the price gets to this number, the less profitable gold-mining companies become. Because of this, my reasoning is that the $900 to $1,200 range will be the low end for gold.
It's basic supply and demand. As gold approaches parity with the cost of production, production will slow, reducing supply in the marketplace. If demand stays the same or increases, then the price will rise on the smaller supply.
Why Gold Has Fallen
The debate rages on as to what caused gold's rapid descent. Some analysts blame Cyprus banks being forced to dump gold to pay for a bailout. Some blame other central banks selling to large speculators winding down positions.
It really doesn't matter why the sell-off occurred. The only thing that matters is what is going to happen next.
Knowing the fundamentals of why a move occurred gets you only so far when it comes it investing. The other half of the equation is the technical factor.
Technical analysis deals with price itself and teaches that all the fundamental factors of a price move are already inherent in the price. It also teaches that by studying past price moves, an educated guess can be made about what the future holds.
With that said, let's take a look at gold's technical picture.
As you can see on the chart, there have been six bear-flag formations between November and the start of the massive sell-off last week. Every bear flag foretold another move lower.
Now it appears we are witnessing the mother of all bear flags. The price has bounced from a low of $1,322 to $1,433 during the past seven days.
Based on this technical formation, combined with the fundamental factor of gold approaching its production price, I think gold will not move above $1,475 an ounce. In fact, I think gold will fall below $1,200 before fundamental factors conspire to lift it higher.
Risks to Consider: Technical analysis is an inexact science and should be used only to provide general guidelines when it comes to investing. Always use stops and position size properly no matter how compelling an investment may be.
Action to Take --> I think gold is going to drop lower before it takes out $1,450 an ounce on the upside. If $1,475 is taken out, my projection is void. Risk-embracing speculative investors can short the SPDR Gold Trust ETF (GLD) or purchase put options on the same.
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