Gold Price Bull Flag at Inflection Point - Time for Next Rally? Levels for XAU/USD
Gold Price Forecast Overview:
- Signs that the US and China are moving towards an agreement to end the trade war have reduced demand for safe haven assets, such as gold and the Japanese Yen.
- Precious metals tend to underperform during periods of lower volatility as decreased uncertainty reduces the safe haven appeal of gold and silver. Yet of recent, gold prices haven’t followed gold volatility lower. To this end, the 20-day correlation between GVZ and gold prices is 0.12, its weakest since March 28.
- Changes in retail trader positioning gives us a bullish spotgold trading bias.
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Signs that the US and China are moving towards an agreement to end the trade war have reduced demand for safe haven assets, such as gold and the Japanese Yen. But with Brexit talks ongoing, and concerns persisting about global growth – even if G10 currencies’ central banks’ rate cut odds have fallen – traders aren’t ready to throw in the towel on all their macro hedges. In turn, despite the flow of positive news, gold prices have been able to break out of the downtrend from the September. Like silver prices yesterday, this may mean the start of the breakout from the bull flag.
Gold Prices Boosted by Rising 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, when uncertainty decreases, volatility tends to fall, reducing the demand for safety assets.
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 broken to its lowest level since the end of July, currently trading at 13.58. However, as was noted earlier this week, “despite the plunge in gold volatility, gold prices have not followed.”
As a result, the short-term relationship between gold prices and gold volatility has broken down. The 5-day correlation between GVZ and gold prices is 0.05, and the 20-day correlation is 0.12; four weeks ago, on September 27, the 5-day correlation was 0.97 and the 20-day correlation was 0.83.
Much like for silver prices, that gold prices continue to maintain their elevation despite a plunge in gold volatility bodes well for the future.
Gold Price Technical Analysis: Daily Chart - Bull Flag/Descending Channel (October 2018 to October 2019) (Chart 2)
Given that trading is a function of both price and time, it was only a matter of time before the sideways consolidation in gold eventually resulted in price breaching the downtrend from the September swing highs. Yet the breakout attempt today is lacking enthusiasm, with a hammer forming on the daily candle. While the time to rally may be near, it is also possible that a false bullish breakout is afoot.
It thus still holds that “if the bull flag in gold prices is legitimate, a break above the late-September swing high at 1538.58 would need to be achieved. In doing so, gold prices would also retake the uptrend from the May and August 2019 lows. The 100% extension of the move from the May low, the September high, and the October low calls for a target price of 1726.31.”
Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (February to October 2019) (Chart 3)
Recent gold price consolidation on the daily timeframe must be viewed in context of the longer-term technical picture: the gold price inverse head and shoulders pattern that originated earlier this year is still valid. Depending upon the placement of the neckline, the final upside targets in a potential long-term gold price rally vary: 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 22, 2019) (Chart 4)
Spot gold: Retail trader data shows 62.83% of traders are net-long with the ratio of traders long to short at 1.69 to 1. The number of traders net-long is 5.22% lower than yesterday and 8.74% lower from last week, while the number of traders net-short is 3.04% higher than yesterday and 18.67% 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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