Gold Price Top Takes Shape - Bull Flag or Head and Shoulders? Key Levels for XAU/USD
Gold Prices Overview:
- Gold prices may be due for a short-term pullback. However, there are a few scenarios that could play out: a less aggressive descending channel that could be a bull flag; or a more aggressive head and shoulders pattern.
- 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 -0.22, and the 20-day correlation is 0.75.
- Changes in retail trader positioning gives us a further mixed spot gold trading bias.
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The end of September produced a wave of selling in precious metals, thanks in part to their strong performance over the course of Q3’19: profit taking and portfolio rebalancing were the key factors in driving flows. With the DXY Index acting out its best rendition of ‘King Dollar’ thus far in 2019, coupled with higher US Treasury yields, both gold and silver prices have been hit hard in recent days. Depending upon one’s perspective, however, the near-term topping efforts may not necessarily mean the end of the multi-month bull moves.
Gold Prices Weighed Down by Easing 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. Heightened uncertainty in financial markets due to increasing macroeconomic tensions (like US-China trade war or the prospect of a no-deal, hard Brexit, for example) increases the safe haven appeal of gold and silver.
On the other hand, reduced uncertainty in financial markets due to decreasing macroeconomic tensions (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 October 2019) (Chart 1)
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 continued to trade lower after its late-September spike, moving to 15.37 at the time of writing. Gold volatility levels remain below its 2019 high (and highest closing level since December 2017) set on August 15 at 18.72.
The 5-day correlation between GVZ and gold prices is -0.22, and the 20-day correlation is 0.78; four weeks ago, on August 20, the 5-day correlation was 0.88 and the 20-day correlation was 0.29. Its atypical for the 5-day correlation between gold prices and gold volatility to turn negative: such an event has only happened once since May 1 (on August 29). Traders should monitor the evolution of this relationship in the days ahead for evidence of a changing market environment.
Gold Price Technical Analysis: Daily Chart (AUGUST 2018 to OCTOBER 2019) (Chart 2)
Gold prices are now below the daily 8-, 13-, and 21-EMA envelope, which is aligning in bearish sequential order. Daily MACD has trended below its signal line into bearish territory, while Slow Stochastics are rapidly advancing towards overbought condition. More losses may be on the way – although there may be two scenarios playing out at present time for gold prices.
Gold Price Technical Analysis: Daily Chart – Head and Shoulders Pattern (February to October 2019) (Chart 3)
In our last gold price technical forecast updated, it was noted that “Failure to achieve a new high, combined with a break of the uptrend from the May low, would suggest a top is in place otherwise; below 1479.73 a head and shoulders pattern may take shape for gold prices.” Indeed, on September 30, a close below 1479.73 was achieved, setting up the potential for a short-term topping pattern in gold prices now that the uptrend from the May and August 2019 lows was broken.
If this is a head and shoulders topping pattern, the head comes in at 1556.88 and the neckline comes in at 1479.73, yielding a measured move down to 1402.58. This would not produce a break of the August 1 bullish outside engulfing bar low at 1400.38.
Gold Price Technical Analysis: Daily Chart – Bull Flag/Descending Channel (February to October 2019) (Chart 3)
If gold prices are trading in a descending channel, then support may not be that far away. Measured from the September swing highs, the descending channel suggests support may around current prices, down to 1460 through the end of the week. If the descending channel support is respected, it may not be wise to take on such an aggressively bearish view: this could be a bull flag taking shape. If a bull flag is forming in gold prices, then more gains may be on the horizon through the end of 2019.
Gold Price’s Longer-term Bottoming Effort Still Valid
The longer-term gold price inverse head and shoulders pattern initiated in the first half of 2019 remains valid despite the potential for near-term weakness. 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 calls for a final target at 1685.67; aggressively, drawing the neckline breakout against the August 2013 high at 1433.61 calls for a final target at 1820.99. Only a break below the August 1 bullish outside engulfing bar low at 1400.38 would draw into question the longer-term bullish potential.
IG Client Sentiment Index: Spot Gold Price Forecast (October 1, 2019) (Chart 5)
Spot gold: Retail trader data shows 68.4% of traders are net-long with the ratio of traders long to short at 2.17 to 1. The number of traders net-long is 5.5% lower than yesterday and 4.1% higher from last week, while the number of traders net-short is 9.3% higher than yesterday and 14.0% 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.
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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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