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Gold Price Forecast: Breakout or Breakdown? - Key Levels for XAU/USD

Gold Price Forecast: Breakout or Breakdown? - Key Levels for XAU/USD

2019-12-24 17:00:00
Christopher Vecchio, CFA, Sr. Currency Strategist
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Gold Price Forecast Overview:

  • Gold prices are up nearly 1% in December thus far while the US S&P 500 is up over 2.5%.
  • The resiliency of gold prices can’t be ignored, even during the upcoming illiquid holiday trading period. That gold volatility has moved back towards its yearly lows while gold prices have stayed elevated is an important development that shouldn’t be dismissed.
  • According to the IG Client Sentiment Index, gold prices continue to have a sideways trading bias.
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Gold Gets Ready for the Holidays

Santa Claus came early this year, as global equity markets, led by US stocks, rally to fresh all-time highs day-after-day. Yet during this melt-up of risk assets as well as US Treasury yields, one asset class has seemingly been unshaken: precious metals. Of note, gold prices are up nearly 1% in December thus far while the US S&P 500 is up over 2.5%.

This begs the question: is the current market environment another ‘canary in the coal mine’ for gold prices? The resiliency of gold prices can’t be ignored, even during the upcoming illiquid holiday trading period.

Gold Volatility Keeps Heading Lower…but Gold Prices Are Not

Precious metals like gold have a relationship with volatility unlike other asset classes. While other asset classes like bonds and stocks 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) increases the safe haven appeal of gold. On the other hand, decreased volatility tends to harm gold prices. That gold volatility has moved back towards its yearly lows while gold prices have stayed elevated is an important development that shouldn’t be dismissed.

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (December 2016 to December 2019) (Chart 1)

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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) was trading at 9.51; in our last update on gold volatility, GVZ was trading at 10.89. As it were, gold volatility has fallen to its lowest level since June.

In turn, the correlations between gold prices and gold volatility have eroded: the 5-day correlation between GVZ and gold prices is 0.22 while the 20-day correlation is -0.09; in the prior gold volatility update, the 5-day correlation was 0.30 and the 20-day correlation was 0.68.

Gold Price Technical Analysis: Daily Chart - Descending Channel (December 2018 to December 2019) (Chart 2)

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Over the past two years, whenever gold volatility has plunged but gold prices have held their ground, the development typically preceded a rally by gold prices. The rationale being that if an environment defined by low gold volatility isn’t eroding gold price action, then gold’s fundamental underpinning is probably strong than presumed.

To this end, despite the upcoming holiday period into the New Year, traders should be on the lookout for a potential bullish breakout in gold prices. A bullish outlook for gold prices would only be valid if the descending channel from the September and November highs breaks, which would occur above 1475 by the end of 2019. Trading is a function of both price and time, after all.

For now, gold prices are pushing above the daily 5-, 8-, 13-, and 21-EMA envelope, which is in neither bearish nor bullish sequential order. Daily MACD is trending higher, still in bearish territory, while Slow Stochastics hovering above their median line.

Failure to achieve a bullish breakout would setup the necessary reversion trade within the descending channel, opening a return towards 1400 in early-2020. The next several weeks will be of great consequence for gold price’s near-term technical structure.

Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (July 2011 to December 2019) (Chart 3)

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The weekly timeframe continues to move at a snail’s pace, and there is no change since the last gold price forecast update. The gold price pullback since the October Fed meeting 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 for gold prices. It’s worth noting that the weekly 26-EMA – the six-month average – has held up as support on a closing basis since gold prices first returned to it during the second week of November 2019; a break below here could be an ominous signal.

IG Client Sentiment Index: Gold Price Forecast (December 20, 2019) (Chart 4)

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Gold: Retail trader data shows 67.70% of traders are net-long with the ratio of traders long to short at 2.10 to 1. The number of traders net-long is 0.96% lower than yesterday and 0.91% higher from last week, while the number of traders net-short is 6.57% higher than yesterday and 29.36% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests 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 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 cvecchio@dailyfx.com

Follow him on Twitter at @CVecchioFX

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