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Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

2020-01-21 15:20:00
Christopher Vecchio, CFA, Sr. Currency Strategist
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Gold Price Forecast Overview:

  • Gold prices have stagnated after a strong start to the new year. Now, technical studies suggest that more near-term weakness may be lurking as a near-term top may be in place at the 61.8% retracement of the 2011 high/2015 low range.
  • The correlations between gold prices and gold volatility have eroded, insofar as the decline in gold volatility has outpaced the losses by gold prices.
  • According to theIG Client Sentiment Index, gold prices have a near-term bearish trading bias.

Gold Prices Struggle as Geopolitical Tensions Ebb

Gold prices have stagnated after a strong start to the new year. A lack of escalation in tensions between the US and Iran tamped down the shift to safe haven assets by market participants, undercutting investor demand for precious metals. Amid a resurgent US Dollar (via the DXY Index) through the first three weeks of January, gold prices have started to lose their luster. Now, technical studies suggest that more near-term weakness may be lurking as a near-term top may be in place at the 61.8% retracement of the 2011 high/2015 low range.

Gold Volatility Continues to Pullback

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 increases the safe haven appeal of gold. On the other hand, decreased volatility tends to harm gold prices.

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (December 2016 to January 2020) (Chart 1)

Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

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) is trading at 11.42; in our last update on gold volatility on January 6, GVZ was trading at 12.80. Gold volatility has fallen sharply since the first week of January, when it had reached a three-month high.

The correlations between gold prices and gold volatility have eroded, insofar as the decline in gold volatility has outpaced the losses by gold prices. The 5-day correlation between GVZ and gold prices is 0.72 while the 20-day correlation is 0.42; in the prior gold volatility update, the 5-day correlation was 0.80 and the 20-day correlation was 0.93.

Gold Price Technical Analysis: Daily Chart (January 2019 to January 2020) (Chart 2)

Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

In our last gold price forecast, it was noted that “while gold prices are continuing a longer-term bottoming effort, they have not officially transitioned from ‘bearish correction’ to ‘bullish reversal’; as a result, we must treat recent efforts by gold prices as a sign that a near-term top against the 61.8% retracement may be in place.”

In technical analysis, Fibonacci retracements are based around the concept of the Golden Ratio, 1.618, or phi; the 61.8% retracement is the inverse of phi and is deemed the ‘make or break’ level to determine if price action is ready to embark on a new trend.

In this case, the 61.8% retracement encompasses the entirety of the 2011 high to 2015 low range at 1598.97; gold prices have not been able to climb back through said level after briefly clearing it during the first week of January.

At present time, gold prices remain intertwined around their daily 5-, 8-, 13-, and 21-EMA envelope, which is in neither bearish nor bullish sequential order. A bearish engulfing bar appears to be forming on the daily candle (at the time this report was written), further evidence that recent gold price action is indicative of a near-term top. Daily MACD has issued a sell signal (albeit in bullish territory), while Slow Stochastics have fallen below the median line into bearish territory.

More corrective price action may be ahead for gold prices in the near-term.

Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (May 2011 to January 2020) (Chart 3)

Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

Gold prices have not made much progress after spiking to a seven-year high during the first week of January. It thus still holds that the rally and rejection at the 61.8% retracement (1586.97) 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 and guiding gold price action.

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, 2019 bullish outside engulfing bar low at 1400.38 would draw into question the longer-term bullish potential for gold prices. If the 61.8% retracement at 1586.71 is indeed cleared out, then the odds of a move up to the head and shoulders targets would increase materially.

IG Client Sentiment Index: Gold Price Forecast (January 21, 2020) (Chart 4)

Gold Price Forecast: Churning Through a Near-term Top - Key Levels for XAU/USD

Gold: Retail trader data shows 68.81% of traders are net-long with the ratio of traders long to short at 2.21 to 1. The number of traders net-long is 0.38% lower than yesterday and 7.64% higher from last week, while the number of traders net-short is 7.98% lower than yesterday and 5.51% lower 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.

Traders are further net-long than yesterday and last week, and the combination of current sentiment and recent changes gives us a stronger gold-bearish contrarian trading bias.

--- 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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