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Gold Prices Testing Key Trend Support as US Yields Surge - Levels for XAU/USD

Gold Prices Testing Key Trend Support as US Yields Surge - Levels for XAU/USD

Christopher Vecchio, CFA, Senior Strategist

Gold Prices Overview:

  • Gold prices have returned to key trend support dating back to May, raising the stakes ahead of the September Fed meeting next week.
  • Precious metals underperform during periods of lower volatility as decreased uncertainty reduces the safe haven appeal of gold and silver. To this end, the 5-day correlation between GVZ and gold prices is 0.53; and the 20-day correlation is 0.81.
  • Retail positioningwarns that the current spot gold price trend may continue lower in the short-term.

Looking for longer-term forecasts on Gold and Silver prices? Check out the DailyFX Trading Guides.

Gold prices continue to struggle to regain their footing in an environment defined by cooling tensions on the US-China trade war front. The latest truce between the world’s two largest countries has provoked a recalibration of easing expectations from the G10 currencies’ central banks, in turn sending sovereign bond yields higher across the developed world. The sharp rise in US Treasury yields in particular can be pointed to as a reason for gold’s recent struggles.

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. On the other hand, environments that produce rising real yields tend to be the most bearish for precious metals.

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.

Rising US real yields means that the spread between Treasury yields and inflation rates isincreasing. If precious metals yield nothing (no dividends, coupons, or cash flows), they would be ill-suited to hold when US real yields rose.

US Treasury 10-year Yield Technical Analysis: Daily Chart (June 2016 to SEPTEMBER 2019) (Chart 1)

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Since hitting a yearly low and its lowest level since July 2016 on September 3 at 1.464%, the US Treasury 10-year yield has gained more than 40-bps to move up to 1.866%. The sharp retracement higher by US yields has gone hand-in-hand with Fed funds futures and Eurodollar contracts showing a decreased likelihood of aggressive Fed rate cuts over the coming months; the reduction in uncertainty around the US-China trade war is reducing the need and desire by investors to hold safe have assets.

Gold Prices Dragged Lower by Falling Gold Volatility

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 (like the US-China trade war or Brexit, for example) increases the safe haven appeal of gold and silver. On the other hand, reduced uncertainty (like the US-China trade war talks being announced for October or a no-deal, hard Brexit being postponed) decreases the desire to hold onto precious metals.

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (November 2016 to September 2019) (Chart 2)

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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) continues to pullback, back down to 14.32, but remains above its four-week low on August 21 at 10.98. Gold volatility levels continue to come down sharply from their 2019 high (and highest level since December 2017) at 18.72.

The 5-day correlation between GVZ and gold prices is 0.53; and the 20-day correlation is 0.81 (one month ago, on August 13, the 5-day correlation was 0.81 and the 20-day correlation was 0.89). It still holds that gold prices will remain weak if gold volatility continues to trend lower.

Gold Price Technical Analysis: Daily Chart (AUGUST 2018 to SEPTEMBER 2019) (Chart 3)

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In our most recent gold price technical forecast update, when gold prices were trading above 1497, it was noted that “a lot of technical damage has been done to the gold price rally (particularly in light of the failed breakout attempt)…. the August 13 doji candle is coming into play.”

Gold prices have continued to struggle in recent days, falling as low as 1483.22 earlier this week. Prices are fully below the daily 8-, 13-, and 21-EMA envelope, suggesting bearish momentum is increasing. Daily MACD continues to trend lower (albeit in bullish territory), while Slow Stochastics are nestled in oversold condition.

It still holds that, “the [August 13] doji support coincides with the rising trendline from the May 30 and August 1 lows, the backbone of the uptrend over the past four months. A break below this level around 1479.73 would suggest that a near-term top is in place for gold prices.”

GOLD PRICE TECHNICAL ANALYSIS: WEEKLY CHART (AUGUST 2011 TO SEPTEMBER 2019) (CHART 4)

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When the gold price inverse head and shoulders pattern began to breakout in June, it was noted that “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.”

Gold prices continue to trade above the weekly 8- (two-month) and 13-EMAs (one-quarter), and gold prices are retesting the weekly 8-EMA for only the second time since the end of May (the other occurring on August 1). Weekly MACD continues to trend higher, although Slow Stochastics have started to pullback from overbought territory. For the time being, there hasn’t been convincing enough price action to suggest that the longer-term bullish multi-year inverse head and shoulders pattern has been invalidated.

IG Client Sentiment Index: Spot Gold Price Forecast (September 13, 2019) (Chart 5)

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Spot gold: Retail trader data shows 69.5% of traders are net-long with the ratio of traders long to short at 2.28 to 1. The number of traders net-long is 7.1% lower than yesterday and 7.8% higher from last week, while the number of traders net-short is 1.3% higher than yesterday and 14.9% 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. Positioning is less net-long than yesterday but more net-long from last week. The combination of current sentiment and recent changes gives us a further mixed spot gold trading bias.

FX TRADING RESOURCES

Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail at cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

View our long-term forecasts with the DailyFX Trading Guides

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

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