Gold Prices Proving Resilient During Correction as Gold Volatility Drops
Gold Price Talking Points:
- Gold volatility has pulled back significantly in recent days, but gold prices have not fallen as much as the gold volatility contraction would imply.
- Gold volatility, as measured by the Cboe’s ETF, GVZ (which tracks the 1-month implied volatility of gold as derived from the GLD ETF option chain) has fallen by nearly -25% over the past week.
- Retail traders’ holdings are beginning to warn that positioning may weigh on the gold price rally soon.
The start of July and Q3’19 has been defined by the market reaction to the G20 summit in Osaka, Japan. With the US and China agreeing to resume discussions to end the trade war, risk appetite has been bolstered with global equity markets running higher. The linchpin for sentiment, of course, has been speculation over the Federal Reserve’s interest rate cut cycle: will the US-China trade war provoke the FOMC into an emergency interest rate cut at the July Fed meeting?
Gold Price Forecast Remains Bullish as Traders Prove Skeptical of US-China Trade Talks
Even after the G20 summit in Osaka, Japan, the market reaction has been limited in some regards, particularly from the US Dollar’s (via the DXY Index) point of view. Fed rate cut odds have not changed in a meaningful way around the G20 summit, with three 25-bps rate cuts still discounted by June 2020. To this end, there hasn’t been a recovery in US Treasury yields, with the US 10-year Treasury yield consolidating around 2.000% the past week; in turn, US real yields (nominal Treasury yields adjusted for inflation) have not been able to recover. As long as US yields don't climb higher, there's little good reason to abandon the longer-term bullish forecast for gold prices.
Gold Price Pullback Shouldn’t Have Come as a Surprise
As the gold price correction takes shape, it’s important to put recent price action in a larger context. It appears that the recent move lower by gold prices is simply another instance where the market was exhausted, or ‘overbought.’ At the start of last week we noted that “Gold prices had exhibited the same type of price action it had in the previous five instances in which gold prices in which gold prices were more than 2% above their daily 21-EMA (i.e. overbought). During those prior instances, gold prices averaged a 1-week return of -0.55%.” Since the 2019 high established last Tuesday, gold prices have come down by more than -3% - a deeper pullback than recent episodes, but still not a surprise nonetheless.
Gold Volatility Contracts in a Big Way but Gold Prices Don’t Follow
We’ve been of the mindset that gold volatility has been a significant factor supporting the gold price rally in recent weeks. If volatility is a measure of uncertainty, gold volatility’s expansion was rooted in the uncertainty created by the US-China trade war and its potential impact on Fed interest rates. While other asset classes don’t like increased volatility (signaling greater uncertainty around cash flows, dividends, coupon payments, etc.), precious metals tend to benefit from periods of higher volatility as uncertainty increases the appeal of gold’s and silver’s safe haven appeal.
GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2016 to July 2019) (Chart 1)
Just last week, gold volatility (as measured by the Cboe’s gold volatility ETF, GVZ, which tracks the 1-month implied volatility of gold as derived from the GLD option chain) established its highest close of 2019 and its highest close since December 16, 2016. Since hitting the 2019 high at 17.08 on June 25, 2019, GVZ has fallen back by -23% from 17.08 to 13.43.
During the gold volatility expansion from the all-time closing low in GVZ on May 29, 2019 at 8.86 to the 2019 high on June 25, 2019 at 17.08 (92.8% gain by GVZ), gold prices rallied by 11.2%. However, during the recent pullback in gold volatility, gold prices have not fallen as much as the recent relationship would imply: the last time that GVZ was at 13.43, gold prices were near 1350. It stands to reason that gold prices are proving resilient during the recent correction, a sign that recent price action has been corrective rather than the end of the longer-term bottoming effort and inverse head and shoulders.
Gold Price Technical Analysis: Daily Chart (July 2018 to July 2019) (Chart 2)
Last week it was noted that “if the daily 8-EMA is lost, then a deeper setback for gold prices might ensue towards the neckline of the inverse head and shoulders pattern near 1355/65.” Yesterday, gold prices closed below the daily 8-EMA for the first time since May 30, when the bullish outside engulfing bar/key reversal marked the start of the gold price rally. Given that trading is a function of both price and time, traders may want to be patient here and wait to see how the charts shape up before attempting to latch onto the next bullish momentum swing higher in gold prices; more weakness if not sideways price action may be ahead.
IG Client Sentiment Index: Spot Gold Price Forecast (July 2, 2019) (Chart 3)
Spot gold: Retail trader data shows 61.4% of traders are net-long with the ratio of traders long to short at 1.59 to 1. The number of traders net-long is 8.2% higher than yesterday and 2.7% higher from last week, while the number of traders net-short is 7.6% higher than yesterday and 6.7% lower from last week.
We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests spot gold prices may continue to fall. Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger spot gold price-bearish contrarian trading bias.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at email@example.com
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