Gold Prices Begin Next Leg Higher - Breakout Target Levels for XAU/USD
Gold Price Talking Points:
- Gold prices have been lagging their silver counterpart in recent days, but it may be gold’s turn to breakout higher amid another drop in US real yields.
- Precious metals perform better during periods of higher volatility as elevated uncertainty increases the safe haven appeal of gold and silver. To this end, the 5-day correlation between GVZ and gold prices is 0.78; and the 20-day correlation is 0.56.
- Retail positioningwarns that the current spot gold price trend may soon reverse higher despite the fact traders remain net-long.
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The current market environment remains one that allows gold prices to shine. As global growth concerns mount around the US-China trade war, market participants have rushed into sovereign debt, driving down bond yields across the globe. An environment marked by low inflation expectations, moderate actual inflation, and falling nominal bond yields has created a situation where real yields are dropping across developed economies.
WHY DO ‘REAL YIELDS’ MATTER TO GOLD PRICES?
The shifts in US Treasury yields around the latest US-China trade war news feeds directly into one of the most important fundamental underpinnings of precious metals’ rallies: environments that produce falling real yields tend to be the most bullish.
Real yields are inflation-adjusted yields: in this case, the US Treasury 10-year yield minus the headline inflation rate. Why does this matter? Investing is all about asset allocation and risk-adjusted returns. On the asset allocation side, it’s about achieving required returns given the investor’s wants and needs.
If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing? On a real basis, your returns would be lower than otherwise intended.
Falling US real yields means that the spread between Treasury yields and inflation rates are decreasing. If precious metals yield nothing (no dividends, coupons, or cash flows), they would best suited to rally amid falling US real yields.
Gold Price Action Guided by Gold Volatility
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) has stabilized in recent days after hitting a three-week low on August 21 at 10.98. GVZ had risen back to 17.61 at the time of writing.
GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (November 2016 to August 2019) (Chart 1)
While other asset classes don’t like increased volatility (signaling greater uncertainty around cash flows, dividends, coupon payments, etc.), precious metals tend to benefit during periods of higher volatility as heightened uncertainty increases the safe haven appeal of gold and silver.
The 5-day correlation between GVZ and gold prices is 0.78; and the 20-day correlation is 0.56 (one month ago, on July 22, the 5-day correlation was 0.60 and the 20-day correlation was 0.62). It thus holds that higher gold volatility will be a positive development for gold price action.
Gold Price Technical Analysis: Daily Chart (AUGUST 2018 to AUGUST 2019) (Chart 2)
Until yesterday, gold price action had been neutral since August 13’s doji candle. The doji candle’s range between 1479.73 and 1534.89 was just tested yesterday at the high end; indeed, with Tuesday’s close at 1542.46, it now appears that a topside breakout may be underway.
Bullish momentum has firmed up, with both daily MACD and Slow Stochastics have turned higher in bullish territory in recent days. Similarly, gold prices are comfortably above their daily 8-, 13-, and 21-EMA envelope.
The measured move for the bullish breakout by gold prices is 1590.05.
Relationship Between Gold Prices and Gold Volatility Feels Familiar
In our most recent gold price technical forecast update, it was noted that “like at the end of May, and again at the beginning of July, gold price action has proved resilient in an environment marked by a significant pullback in gold volatility and drop in bullish momentum indicators. It would stand to reason that the current uptrend not only remains intact, but that traders are simply biding their time before engaging the uptrend. Any weakness in the near-term thus may be best viewed as profit taking rather than a top coming into place.” Now that gold prices have started to breakout to the topside, this view may be validated.
GOLD PRICE TECHNICAL ANALYSIS: WEEKLY CHART (AUGUST 2011 TO AUGUST 2019) (CHART 3)
Long-term, gold prices continue to advance in the context of a multi-year inverse head and shoulders pattern. When the gold price inverse head and shoulders pattern began to breakout in June, “The placement of the neckline determines the final upside targets in a potential long-term gold price rally: conservatively, drawing the neckline breakout against the January 2018 high at 1365.95; aggressively, drawing the neckline breakout against the August 2013 high at 1433.61 calls for a final target at 1820.99.”
This longer-term bullish perspective remains valid. Gold prices continue to trade above the weekly 8- (two-month) and 13-EMAs (one-quarter), and both weekly MACD and Slow Stochastics trending higher. Bullish momentum remains strong on longer-term timeframes as gold prices close in on the 61.8% retracement of the 2011 high to 2015 low at 1586.71.
IG Client Sentiment Index: Spot Gold Price Forecast (August 28, 2019) (Chart 4)
Spot gold: Retail trader data shows 61.7% of traders are net-long with the ratio of traders long to short at 1.61 to 1. The number of traders net-long is 3.0% lower than yesterday and 3.5% lower from last week, while the number of traders net-short is 11.2% higher than yesterday and 5.0% higher 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. Yet traders are less net-long than yesterday and compared with last week. Recent changes in sentiment warn that the current spot gold price trend may soon reverse higher despite the fact traders remain net-long.
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--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
To contact Christopher Vecchio, e-mail at firstname.lastname@example.org
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