Investors often assume there must be a news catalyst or a "reason" for price movement when a stock, commodity, or index breaks out and declines significantly. While that is often true, sometimes breakouts can be driven merely by a feedback loop between sellers. Sellers can hit a tipping point when prices drop just enough to trigger a group of sell orders, which in turn drives prices lower and more sellers enter the market — rinse and repeat. This is likely what happened to gold on Friday, June 15, but can these feedback loops be predicted?
Sometimes Prices in Gold Decline for No Good "Reason."
In statistics, there is a phenomenon called "Poisson clumping" that describes what happens when random data seems to clump together. This is what happens when you buy a bag of M&M's and draw out five brown ones in a row. It just means independent events (or traders) can sometimes clump closely together without a specific reason why.
On Friday, gold prices fell below $1,290/oz, which may have just been a random fluctuation, but enough sell orders were triggered to cause a feedback loop creating more sell orders. Gold bulls and bears had estimates and orders clumped together just under that level such that if gold sold off, it was likely to go further.
For traders, like myself, who do not agree that the market is purely random, these clusters of orders and estimates are what help create support and resistance levels. Once a level is broken, investors are often "anchored" to the prior price and tend to sell the market again at resistance, or buy the market at support.
Whether fully random or not, can these breakouts be predicted in advance? While specific prices and timing may be impossible to predict, market technicians will use intermarket analysis to give them an edge in identifying a point where a dramatic break (on "no news") is more likely to occur, and gold was a prime candidate for a big drop after Thursday's surprise in the currency market.
Gold is priced in dollars and therefore has a strong inverse relationship with the greenback. If the dollar rises, gold prices should fall. However, sometimes that reaction is delayed and a sort of tension will build in the market which was the case on Friday. As you can see in the following chart, gold prices, represented by the SPDR Gold ETF (GLD), and the dollar, represented by the Invesco Dollar Bull ETF (UUP), moved quickly in the same direction on Thursday. This kind of dramatic divergence increased the potential that sell orders would be clumped together under gold prices and that selling could start a feedback loop on Friday.