Gold is a falling knife. I am not advising investors try to catch it. The trend is down, and as of today a fairly sizeable technical pattern is broken to the downside.
 
But there is something intriguing now about the yellow metal, and it has everything to do with fear.
 
Investors seem to be willing to dump their gold holdings en masse even at already depressed levels, following the perceived lead of China, which reported last week that it wasn’t holding as much gold as originally thought.
 
It is ironic that gold, recently trading at a 5-year-low just above $1,100, is supposed to be the hedge investors use when they are fearful about other things, such as the economy. But right now, the fear is for gold. Never mind that central banks around the globe have been selling gold for years.
 
From a technical point of view, gold broke down last Friday from a nine-month triangle-like pattern and arguably a two-year pattern of similar shape (see Chart 1). While gold futures are a better way to examine the nitty gritty in the technicals, most individual investors have access to the next best thing, the SPDR Gold Shares exchange-traded fund.

Chart 1

Gold


On the surface, the breakdown came on high volume in an environment where cumulative, or on-balance, volume was already bleeding profusely. Said another way, supply was swamping demand and investors clamored to get out.
 
Some technical analysts might calculate a downside projection based on the short-term pattern at $975 per ounce, or $850 based on the long-term pattern. They measure the height of the pattern from peak to flat base and project that down from the break point. I think that is a bit aggressive and instead look at $1,000 and $915, respectively, but even that may be moot based on two other factors, both of which suggest the bottom is actually near.
 
First, prices are now approaching the 50% retracement level of the 2001-2011 rally, which is at $1,089. Gold traded at $1,104 Monday afternoon after briefly dipping to $1,080 overnight. That is close to what could be an important support zone.
 
But even more striking is the acceleration in the decline since last month. The short-term trend got steeper and momentum got stronger. And the gold ETF, which is not as active as gold futures in the overnight sessions, shows consecutive gaps to the downside.
 
Gaps are areas on the chart where there is no trading, reflecting the large imbalances that build up when the market is closed. While the ETF is prone to showing these gaps, it is hard to find a series of them in the past to match recent action. The selling seemed to snowball and volume jumped to levels well above its recent average.
 
Put them together – an ever increasing slope of decline, gaps and high volume – and we get a panicky situation suggesting investors are getting out regardless of the price. That smells of capitulation, and headlines in some popular financial sites are stoking those flames.
 
But is that good enough? Maybe, especially if we look at the cratering chart of the Market Vectors Gold Mining ETF. The ETF was down more than 10% Monday. This gold stock measure also sports the accelerating short-term decline, gaps, oversold momentum and heavy volume. And worse, it has just dropped sharply below its 2008 low, which coincided with the bottom of the commodities bear market of 2007-2008 (see Chart 2).

Chart 2

Gold Miners ETF


Normally, a drop below such a support would be very bearish, but the speed and ferocity of the decline also smells of capitulation and an overshoot of support thanks to momentum.
 
Trying to pick an exact bottom in gold and mining stocks is a fool’s game. Being wrong by one day can result in steep losses as holders of Newmont Mining might attest, with its single-day decline Monday in the 11% area. But when there is fear in the air we should start to look for signs that it is time to buy. For now, falling to a multi-year low is not the market’s sign that things are better.
 
I will watch for a sharp rebound here and possibly even a follow-through day signal that is often found in the stock market. In a nutshell, the signal looks for a surge in price and volume about a week into the rebound attempt. It seeks to avoid falling for oversold bottom fishing moves and jump back into a market when there is proof that demand has come back.
 
Another sign would be found in the Commodity Futures Trading Commission’s commitments of traders report, to be released next week. It will be interesting to see if speculators continue to press their bearish views while commercial hedgers pivot more to the bullish side. But for that, we will have to wait.
 
The bottom line is that, with fear in the air and blood in the streets, gold and related markets may be in the final stages of their bear markets. Once the turn is made, whether it is this month or later this year, there should be ample technical evidence in place to tell us. But for now, a bottom it is still an unproven theory.
 
Michael Kahn, a longtime columnist for Barrons.com, comments on technical analysis at www.twitter.com/mnkahn. A former Chief Technical Analyst for BridgeNews and former director for the Market Technicians Association, Kahn has written three books about technical analysis.