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Will Increase in Debt Ceiling End Decline in Gold Market?

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Based on today's price action, it seems that a bigger move lower is already underway for the yellow metal.

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Since the US shutdown began, gold has been trading in a tight range between $1,277 and $1,330 per ounce. Although investors have believed that worries over the debt ceiling would be only short-lived, it seems that each day that passed without an agreement tested their nerves.

On Thursday, President Barack Obama agreed to consider a proposal from Republican lawmakers to avert a historic debt default. US House of Representatives Republicans plan to offer Obama a short-term increase in the federal debt limit if he agrees to negotiate with Republicans on certain matters, including funding to reopen the government.

These circumstances present a potential breakthrough in the standoff that has led to a 10-day partial US government shutdown. From today's point of view, it seems that -- thanks to this development -- the yellow metal lost an important support. Please note that gold is considered to be a hedge against political and economic uncertainty by some investors who purchase the metal when such fears run high (and who then reduce their holdings in favor of riskier assets like equities when these concerns fade). Therefore, yesterday, gold fell and touched a one-and-a-half-week low of $1,282 as investors cut back holdings of the haven asset. This is gold's lowest price since the first day of the partial government shutdown. Earlier today, we saw a small pullback to $1,294, however, gold is still heading for a weekly decline. Please note that if the yellow metal closes today below $1,282, it will be its sixth decline in seven weeks, which will extend the year's losses to 23%.

In our previous essay on the price of gold in October 2013, my firm wrote about the debt ceiling issue. Taking into account the fact that debt ceiling talks are becoming increasingly popular in the media, we have decided to highlight this topic today.

In short, in our view, it's highly likely that the debt ceiling will be increased and that the talks about it are really smoke and mirrors, aimed at convincing voters that the deal wasn't coined already a long time ago. In our view, the debt ceiling will be increased because other options are too costly and much harder to put into place politically.

Will an increase in the debt ceiling end the decline in the gold market? Not likely; gold has already declined since the possible increase was mentioned. Besides, we already researched this topic over two years ago.



What we wrote back then remains up to date:
As you might see, gold has roughly followed the rises in the US debt level since 2000. On the other hand, you will also surely notice that there were periods in gold's history when the metal traded without visible correlation with the aforementioned debt. In short, the above chart confirms that growing uncertainty linked to the growing debt pile might fuel the price of gold, however it also confirms that markets cannot follow a given economic indicator with reasonable precision at all times and confirms what we've emphasized many times -- that fundamental factors can only point you the general direction in which a market is going, but they do not provide timing details.

Although the link between gold and the debt ceiling might seem like a strong and positive one, it doesn't really work on a short-term and medium-term basis.

Having discussed the debt ceiling issue and its link to gold, let's now move on to the more recent charts to find out what the current situation in the yellow metal is.

Let's start with a look at the long-term chart (charts courtesy of http://stockcharts.com).


Click to enlarge

This week's price moves were quite visible on a short-term basis. But from the long-term point of view, they didn't change anything since they didn't take gold below the nearest significant support level, which is currently close to $1,285. Gold closed very close to this level, though.

At this time, we might still see an additional upswing. It will not invalidate the bearish outlook as long as it doesn't break above the rising resistance line, which is currently more than $100 above the yesterday's closing price (and a rally this big seems unlikely). On the other hand, we could see a breakdown below the aforementioned support level (gold closed very close to it) and a decline to $1,100 target level.

From the long-term perspective, the outlook is bearish. The biggest question that we have concerning gold is not if it declines, because that seems quite likely, but when it will happen.

Let's look for some answers on the medium-term chart.


Click to enlarge

On the above gold chart, we can see that the head-and-shoulders pattern was completed once again. The breakdown below the neck level hasn't been verified just yet, and since the previous breakdown was invalidated on the very next day, we think that the outlook has deteriorated insignificantly. However, based on today's price action, it seems that a bigger move lower is already underway.

The interesting thing about the gold market at this time is that the short-term support and resistance levels are very close to each other. Therefore, there are only several days that gold can trade without a confirmed breakout above the red declining resistance line or a confirmed breakdown below the neck level of the head-and-shoulders formation. It will have to move above or below one of them and then verify this move. When we see a confirmed breakout or breakdown, it will likely determinate the next short-term move in the gold market. In our opinion, the scenario in which gold declines is more probable, as it is in tune with the medium-term trend. Plus, gold is already below the neck level.

The "problem" with the confirmation of a breakdown and waiting for it (especially given the ways that gold used to plunge earlier this year) is that once gold starts to move lower, it could drop very fast and, as the head-and-shoulders pattern suggests, very far. The head of the pattern is big -- bigger than $100, and that's the type of move that we can see after the formation is completed. It was completed yesterday (without a verification, though), so such a move is now more likely than not.

Summing up, the medium-term outlook for gold remains bearish, and the downward trend is not threatened at the moment. Moreover, gold looks like it's about to verify the breakdown below the head-and-shoulders pattern.

For the full version of this essay and more, visit Sunshine Profits' website.

Twitter: @SunshineProfits
No positions in stocks mentioned.
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