How low could gold go?

The age-old Dalal Street tale of Varmaji and Sharmaji is one many investors know well. Neighbours yet opposites, Varmaji sticks to fixed deposits and rides a Bajaj scooter, while Sharmaji, an active stock investor, also rides a scooter but soon upgrades to a gleaming car during a bull market. With his newfound wealth, Sharmaji enjoys overseas vacations, brimming with optimism and confidence.

Meanwhile, Varmaji, plagued by FOMO (fear of missing out) and spurred on by his wife’s remarks about his “conservative” approach, dives into the stock market at its peak—and is left holding not just the baby, but the bathwater and the tub too. Now he’s forced into the role of a 'long-term investor'—the path most traders take when they buy at the top.

Gold prices in domestic markets have surged over 30% in the past year, largely due to geopolitical turmoil. However, on Monday, prices softened, reflecting global cues as the dollar index slipped to a near two-week low, Reuters reported.

If you've recently bought bullion, Varmaji's story might resonate. But is it really as bleak as it seems?

Chance favours the prepared

In a recent write-up, I anticipated a decline in gold prices, potentially as early as 2024.

Any seasoned investor knows that the best approach to long-term investing is to deploy money gradually, allowing room to average down at lower prices. The long-term bullish outlook for gold remains solid.

With nearly sixty nations set to hold general elections in 2024—a record high—the feel-good factor is palpable. Economic data is being 'massaged,' and promises of reforms, improved living standards, and a better quality of life are resonating globally, driving up prices of riskier assets like equities, bonds, and currencies.

While it's tempting to get swept up in this rally like Varmaji, much of this optimism is more mirage than oasis. When the gloss on global economic data starts to fade, a flight to safe assets will likely begin in earnest. If you thought the recent rally in gold was remarkable, what’s on the horizon for 2025 may be even more dramatic.

Short-term pain, long-term gain

In the near term, margin calls on riskier assets may trigger selling across markets, including bullion, creating opportunities for patient investors to buy from panicked sellers.

Let’s not overlook the interest rate cycle. Many investors expect a swift drop in coupon rates, but I believe they’re mistaken. The days of unchecked currency printing are behind us; any further unbacked currency printing risks sparking inflation protests in multiple countries. This makes bond markets the TINA (there is no alternative) factor.

As central banks continue heavy borrowing through bond sales, investors—having endured low or negative real returns for too long—are demanding (and getting!) higher coupon rates. Bank deposit rates are on the rise, as recent reports show.

The anticipation of lower rates had previously driven exuberance in bullion prices. As investors realize that rates won’t fall as quickly as expected, profit-taking on long positions has become inevitable. The US Fed’s meeting on 7 November will be crucial; if no rate cuts are announced, further declines in gold and silver prices could follow.

Rather than focusing on near-term declines, keep the long-term view in mind. Picture the ‘makeup’ of the global economy running in the rain by 2025 and beyond.

Crystal gazing

The weekly chart of gold in US dollars per ounce speaks volumes. I’ve used the US price as a base since Indian commodities exchanges derive their rates from it, adjusting for the USD/INR currency peg.

Notice how gold’s price consolidated over four years before breaking through a key resistance, marked by a blue trend line. According to Dow Theory, once an old resistance level is breached, it often becomes a solid support. Thus, $2,100/oz is the "hard deck" below which gold is unlikely to fall. If this level is breached—a low 10-20% probability—the rally may lose its momentum.

To gauge potential declines, I’ve plotted a Fibonacci retracement, beginning from the swing low just before the breakout above the four-year resistance. Based on the principles laid out by Constance "Connie" Brown in Technical Analysis for the Trading Professional, a strong rally typically faces a shallow correction, often not exceeding a 61.8% retracement. This “golden ratio” level, as Fibonacci traders call it, offers key support points: $2,482 at the 38.2% level, $2,387 at the 50% mark, and $2,292 at the 61.8% retracement.

For more such analysis, read Profit Pulse.

If you’ve joined the bullion rally recently, brace yourself for some volatility. Those following my previous advice would have prioritized physical bars or coins, with ETFs as a secondary option. I cautioned against futures and options due to their high financing costs (the "cost of carry"), which can add stress via margin calls.

Your call to action

If I were a latecomer to the gold rally, having bought at the peak, I’d calm my nerves, take a breath, and prepare to buy more at the Fibonacci support levels above.

Would I book profits from riskier paper assets to buy more gold on significant declines to Fibonacci support levels? Absolutely. I've laid out my procyclicality theory in financial markets in a previous piece, and I stand by it. My view remains unchanged: In God and gold I trust!

Note: This article relies on data from Wikipedia and TradingView. Its purpose is solely to share interesting charts, data points, and thought-provoking insights—not to provide investment recommendations. For investment considerations, please consult your financial advisor. This article is intended for educational purposes only.

About the author: Vijay L Bhambwani is the author of India's first official commodities trading guide. He designs statistical and behavioral trading models for his family-owned proprietary trading firm. Based in South Mumbai, he has been trading since 1986. Follow him on Twitter at @vijaybhambwani and on his video blog at YouTube.com/vijaybhambwani.

Disclosure: The writer and his proprietary trading organization have no exposure to the gold or silver derivatives contracts discussed here.