Gold Price Watch: The Market Is Terrified of a Broken Neck!

As I write this, gold is up $10 an ounce, but the big action came on Friday. That's when gold tested the "neckline" of a head-and-shoulders pattern. This really worries gold traders, because if gold breaks this neckline convincingly, we could see another 10% to 15% downside in gold.

The test came on rising volume, which in this case is bearish. Measuring the potential move down in dollar terms, I would look for a drop to $1,110 to $1,125.

In this scenario, you don't want to be holding any miners that can't survive at $1,110 per ounce, because the market will sell them hard.  But all gold miners should come under pressure, so there may not be any good options on the bullish side in the short-term. 

If you've been reading my recent posts, you know I think the smart thing to do now is invest in energy.

As for gold, from a bullish perspective, what a broken neckline of a head-and-shoulders pattern means is that we may be coming up to an EXCELLENT buying opportunity.

Think of it.  All the gold miners you ever wanted being sold for pennies on the dollar.  If you are bullish metals longer-term, the bottom that comes after this move is what you've been waiting for.

The bottom will be a moving target. 

In any case, the test isn't over.  And let's look at some gold fundamentals ...

• The major bullish force in gold right now is Chinese consumer demand. And China's annual consumer inflation rate rose to a seven-month high of 3.1% in September. When people are worried about inflation, they tend to buy more gold. In other China news, that country's imports of energy and base metals rose strongly in September, driven by a seasonal pickup in manufacturing and restocking ahead of the October Golden Week holiday.
• The U.S. Congress and President Obama made little to no progress over the weekend on reopening the government and agreeing on a measure to extend the government debt ceiling. So that's putting a safe-haven bid in gold this morning, along with the expected short-covering. On the other hand, the chances of a deal rise with every passing day, unless you're a real pessimist.
• Gold holdings in exchange-traded products (ETFs) dropped 7.6 metric tons to 1,909.8 tons on Oct. 11, the lowest since May 2010. Selling of metal by funds is the biggest bearish force in the market right now.
• Gold supply remains tight in India at the start of festival season, and premiums on physical gold are rising.

This is all stuff to keep in mind as we see gold zig and zag around that neckline this week. Will it break, or are we at the beginning of the next rally? Stay tuned.