Gold set for further declines after China disappoints

Early on Monday morning the bottom fell out of the gold price. A series of massive sell orders hit the markets which tripped a series of stop levels and the outlook for the yellow metal has taken a severe battering. In breaking these key technical levels the arguments put forward by the bulls are now struggling to hold much weight. With both fundamentals and technicals pointing to further weakness in the price, the gold bugs really are on the ropes.

china gold

The catalyst for the move was an announcement on Friday of China’s total holdings of gold. China does not announce its holdings of gold too often, and in the 6 years since the last announcement, its holdings of gold have increased by 57%. It holdings have gone from 1054 tonnes in April 2009 to now stand at 1658 tonnes. This may sound like a significant jump, however the main argument of the bulls has been that China has been buying gold like there is no tomorrow. Some had hoped that perhaps it had bought enough to make it perhaps close to the amount held by Germany (3383 tonnes and the second largest holding) or even close to the largest holder of gold in the world, the US at 8133 tonnes. In this context, a mere 1658 tonnes (leaving it trailing Italy and France as the 6th largest holder of gold in the world) was a considerable disappointment.

Not only that, the grim reality for the bulls is that gold is clearly not a priority for China. The government is just as intent on holding foreign exchange reserves (ie. fiat currency). The percentage of gold to the PBOC’s foreign exchange reserves has actually fallen from April 2009 (1.8%) down to stand at around 1.7% now. Furthermore, the PBOC has increased the money supply of M1 and M2 by 120% in that time. It has clearly not been looking to “back” its currency, the yuan, with gold.

So when the markets opened on Monday morning, there was a series of massive sell-orders that were put through. Apparently 22 tonnes was sold initially, followed by a further massive order to account for a whopping 57 tonnes sold in just a handful of minutes. Again to put this into context, the global production of gold is around 2600 tonnes, so around 2% of global production in a matter of minutes.

This has subsequently meant that there has been a massive breakdown of technical levels on gold priced not only in dollars but also in sterling. Priced in Sterling, the chart below shows a break of the support at £713 which has been a massive support in the past 2 years. (Also, gold priced in Euros has taken a huge hit too.)

gold sterl

Gold priced in US dollars has broken the crucial November low of $1131, but also the next psychological level at $1100 has provided little respite. It is now back at levels not seen since early 2010. That means that the next real support does not come in until $1043 (the 2010 low, from February of that year), whilst there is also a big support around $1000 on the basis that this was the old ceiling resistance from 2008 which should now be supportive on both a price and psychological basis (imagine the number of long term stop-losses just sitting around $1000…).

As a technical analyst the big concern for me also is that there has now been a decisive break clear of the 61.8% Fibonacci retracement of the huge $681 to $1920 bull run which was around $1154 (notice on the chart the consolidation around the 61.8% and also 50% in the last year). This could mean that there will now be a 100% retracement. I would be more interested in how gold reacts around $1000 first though.

gold dollars

Technically there is now key resistance overhead at $1131 (old critical support becomes new resistance) and any rebound back towards $1131 is likely to be seen as a big chance to sell. However, the way gold has reacted since the flash crash, it would appear that the rebound to $1118 could suggest the technical rally may have already been played out. A move back below the $1088 low would certainly continue the decline now.

There are caveats to my view:

  • Everyone is bearish
  • Physical buying will ramp up in the coming weeks with Indian wedding season, moving into Diwali in November.
  • The big sell-off may lead to the closure of mines and reducing production (the cost of production for gold tends to be between $1050/$1100).

However, with the huge disappointment of China’s lack of gold accumulation along with the critical technical price breakdown, the outlook for gold remains bleak for the medium term.

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