Gold Price Forecast: Bullish Breakout Stalls - Key Levels for XAU/USD
Gold Price Forecast Overview:
- Gold prices broke out to fresh yearly highs earlier this week, only to find themselves failing to hold onto the gains. Failure to reach the measured target of the symmetrical triangle would likely foreshadow a deeper pullback.
- The drop in gold volatility is a concerning development for gold prices, which typically trade stronger when measures of volatility are on the rise.
- According to theIG Client Sentiment Index, gold prices may experience some weakness in the coming sessions.
Gold Prices Traded Choppy amid US-China Trade War Fears
Gold prices are dealing with two countervailing forces at the moment, one in the news frequently over the past few months, one that has not made an appearance since the most recent crisis started: the former, the coronavirus pandemic; the latter, the US-China trade war.
Just as global risk appetite is on the mend due to developed economies beginning to lift the onerous veil of The Great Lockdown, the world’s two largest economies appear reading to escalate the trade war anew. Of course, some of this is tied to the coronavirus pandemic itself, with the Trump administration (among other Western world leaders) casting blame on China for its mishandling of the initial outbreak of the scourge.
The deterioration along the US-China trade war front, which has historically been a bonafide positive for gold prices, stands in stark juxtaposition to developments from earlier in the week out of the European Union, where the once-unthinkable has now emerged: the prospect of jointly-issued federalized debt, with Germany’s blessing.
It’s noteworthy that gold prices peaked on the day of this announcement by Germany and France, the EU’s two largest economies; without the latest uptick in US-China trade war tensions, gold prices may have otherwise faced a bigger setback than they have up until this point in time.
For now, the global economy rebound from the coronavirus pandemic is the more persuasive storyline to keep an eye on, as it poses a real threat to gold prices if risk appetite improves. Certainly, anything that moves the European Union further from its existential termination reduces the appeal for a safe haven like gold.
Gold Volatility Continues to Drop, However
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. To this end, we may be seeing some long-term exposure covered as this threat has dissipated, leading to a decline in measures of gold volatility even as the US-China trade war threatens to heat up and derail what will be an extremely fragile recovery from the coronavirus pandemic.
GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2008 to May 2020) (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) is trading at 19.09, less than 25% of the absolute high set in mid-March near 85.50. We still maintain the belief that, given the current environment, falling gold volatility is rather neutral for gold prices, whereas rising gold volatility is still proving bullish.
As such, the 5-day correlation between GVZ and gold prices is -0.15 while the 20-day correlation is -0.52; one week ago, on May 15, the 5-day correlation was -0.83 and the 20-day correlation was -0.22; and one month ago, on April 9, the 5-day correlation was -0.39 and the 20-day correlation was 0.06. The erosion of the 20-day correlation highlights the fact that the typical relationship between gold prices and gold volatility is currently absent.
Gold Price Technical Analysis: Daily Chart (May 2019 to May 2020) (Chart 2)
On May 18, gold prices were able to climb to a fresh yearly high, following through on the prior Friday’s breakout from the sideways range carved out between the April 14/2020 high at 1747.72 and the April 21 swing low at 1661.42. This was expected, as we noted ahead of the breakout that “given that gold prices rallied into this consolidation, the market retains an upside bias.”
Yet not all is well for gold prices. It was also noted that , “if gold prices do break higher from here, the near-term measured move calls for gains towards 1834.02.” That we’ve witnessed gold prices set a fresh yearly high and immediately turn lower warns of an exhausted market. Failure to reach the measured target of the symmetrical triangle would likely foreshadow a deeper pullback in the near-term, particularly if gold prices were to move below the daily 21-EMA (currently 1715).
Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (May 2011 to May 2020) (Chart 3)
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 22, 2020) (Chart 4)
Gold: Retail trader data shows 73.18% of traders are net-long with the ratio of traders long to short at 2.73 to 1. The number of traders net-long is 0.12% lower than yesterday and 1.56% lower from last week, while the number of traders net-short is 6.27% lower than yesterday and 13.13% 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
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