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Gold Price Forecast: Flag Takes Shape as Gold Volatility Drops - Key Levels for XAU/USD

Gold Price Forecast: Flag Takes Shape as Gold Volatility Drops - Key Levels for XAU/USD

Christopher Vecchio, CFA,
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Gold Price Forecast Overview:

  • Gold prices have traded sideways through the start of May, maintaining the bullish flag pattern following the April rally into fresh 2020 highs.
  • Gold price’s resiliency in the face of declining gold volatility may once again be a good omen, as it so often has been the case over the past year.
  • According to the IG Client Sentiment Index, the outlook remains neutral as traders have made few changes to their gold positioning.
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Gold Prices Continue their Sideways Grind

Bearish outside engulfing bar. Bullish piercing bar. Doji. The past three days of action in gold prices has led to contradictory signals from Japanese candlesticks – first the sign of a downturn becoming more aggressive, then a reversal candlestick immediately thereafter, and now the formation of today’s doji candle, a neutral, undecisive output by the market.

And so it goes for gold prices: the sideways grind that defined the second half of April has continued its slog into May. The evidence thus far remains scant and uncompelling, particularly due to the lack of follow through, for a more aggressive move in the near-term. With risk appetite showing signs of improving, it would seem that there are a few near-term hurdles that gold deal with before taking a swing at fresh yearly highs.

Gold Volatility Pulls Back, Undercuts Gold Price Potential

Gold prices have a relationship with volatility unlike other asset classes, even including precious metals like silver which have economic uses. While other asset classes like bonds and stocks don’t like increased volatility – signaling greater uncertainty around cash flows, dividends, coupon payments, etc. – gold tends to benefit during periods of higher volatility. Heightened uncertainty in financial markets due to increasing macroeconomic tensions increases the safe haven appeal of gold.

Read more: How Do Politics and Central Banks Impact FX Markets?

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2008 to May 2020) (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) is trading at 23.72, breaking its coronavirus pandemic low set on March 16 at 23.96. It’s worth noting that, despite gold volatility breaking its coronavirus pandemic lows, gold prices have not: gold prices were trading at 1696.94 at the time this report was written; on March 16, gold prices traded as low as 1451.43.

As such, the 5-day correlation between GVZ and gold prices is 0.08 while the 20-day correlation is -0.41; one week ago, on April 28, the 5-day correlation was 0.68 and the 20-day correlation was -0.43; and one month ago, on April 7, the 5-day correlation was 0.99 and the 20-day correlation was -0.55.

It remains the case that, as has occurred many times over the past year, when gold volatility falls but gold prices do not follow, leading to a situation of negative correlations in the short-term, it has typically indicated a digestion period for the market prior to further gains. If history is a guide, the recent sideways move in gold prices in context of the decline in gold volatility may be setting up the conditions for a rally after all.

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

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The lack of significant movement over the past few weeks has left much of our near-term gold price forecast intact: “Gold prices continue to consolidate below two key Fibonacci levels, having achieved significant upside targets in the context of both recent and longer-term moves. The two Fibonacci levels referenced are (1) the 100% extension taken from the May 2019 low, September 2019 high, and November 2019 low, with a calculated target at 1736.39, and (2) the 76.4% retracement of the 2011 high to 2015 low range at 1714.66. These have proven to be formidable resistance over the past month.

It thus still holds that the short-term sideways range has been carved out between the April 14/2020 high at 1747.72 and the April 21 swing low (which found support at the daily 21-EMA) at 1661.42. To this end, given the gold prices rallied into this consolidation, the market retains an upside bias. If gold prices do break higher from here, the near-term measured move calls for gains towards 1834.02. If gold prices break the April 21 low of 1661.42, the measured target is 1575.42.”

It should be noted that momentum has neutralized in recent days, now that gold prices are enmeshed among the daily 5-, 8-, 13-, and 21-EMA envelope, which is in neither bearish nor bullish sequential order. Daily MACD is falling, albeit in bullish territory, while Slow Stochastics are meagerly rising their median line. The coiling continues.

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

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Gold prices have made significant progress within the confines of the multi-year inverse head & shoulders pattern, achieving their highest level since November 2012 earlier this week. It thus still holds that the rally into and through the 76.4% retracement (1714.66) must be viewed in context of the longer-term technical picture: the gold price inverse head and shoulders pattern that was triggered in mid-2019 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, if drawing the neckline breakout against the August 2013 high at 1433.61, calls for a final target at 1820.99. This dovetails neatly with the measured move on the daily timeframe looking for gold prices to rally into 1834.02.

IG Client Sentiment Index: Gold Price Forecast (May 5, 2020) (Chart 4)

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Gold: Retail trader data shows 71.85% of traders are net-long with the ratio of traders long to short at 2.55 to 1. The number of traders net-long is 8.82% lower than yesterday and 12.55% higher from last week, while the number of traders net-short is 9.51% higher than yesterday and 7.58% 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.

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 Gold trading bias.

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

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