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A flight to risk leads to gold sell off PDF Print E-mail
Written by George Albert   

Written for First Post
February 4, 2012: A frenzied appetite for risk resulted in a sell off in gold and US treasuries on Friday. Equities rallied in US, which will push up the Indian markets when they open on Monday.

Actually gold sold off from the resistance areas identified in last week's article. (Click here for Gold chart ) Last week we had mentioned that gold was near a level to book profits and also an area to go short. The precious metal entered the level identified in last week's article, stayed there for a few days and then sold off. The area is marked by white horizontal lines on the chart.

Fundamental analysts would say the fall in the price of gold and US treasuries was due to the flight to risk driven by the better than expected economic reports in the US. The US unemployment rate fell more than expected and the private sector added better than expected jobs. Technical analysts would state that the fall was a result of prices hitting an area of resistance. Prices often fall from resistance.

So what should traders depend on--fundamentals or technicals. Last week the gold chart was telling us that prices had a high probability of turning. Fundamental data was not known to anyone till Friday. Hence, it was best to focus on technicals. At the very least the chart told investors not to go long on gold.

The 10-year US treasury had a strong sell off on Friday due to the robust economic releases. (Click here for 10-year US Treasury chart) As equities rallied prices of government bonds fell. This is a natural reaction as investors sell bonds to buy equities. While the instant boost in equity prices on the bond sell off is gratifying to equity bulls, the long term consequences are not positive. A fall in treasury prices means a rise in interest rates, which eventually puts a damper on an equity rally.

So does Friday's price action indicate that the global equity markets are off to the races. Not yet. The Dow has to clear the 13,000 level and it closed at 12,862 on Friday. The S&P 500 on the other hand must clear 1370 after which there is resistance at 1440. On Friday, the index closed at 1344. 

Indian Markets

In our article on January 21, 2012, we had mentioned that Sensex and Nifty were at resistance. We had also stated that if the Sensex closed above 1700 and the NIFTY above 5100, it could rally higher. That's exactly what happened. In previous articles we had also mentioned not to buy the breakout, but to buy after prices pull back to the point of break out. The price action of the Sensex and Nifty last week is a text book illustration.

(Click here for  NIFTY chart and here for SENSEX chart )

The blue horizontal lines on both charts were shown in our January 21 article. Notice how the price broke out and fell back to that level before rallying again.The lines in red are the next resistance levels on the Sensex and Nifty, where prices could reverse. So longs should take profits and if prices break above the resistance levels then traders buy on a pull back to the break out level.