Gold Price Forecast Overview:
- The gold price rally has cooled off in recent days, but that doesn’t mean that the technical structure has turned less bullish. The fundamental argument – that real yields will remain low, if not in negative territory – remains robust as well.
- The plunge in gold volatility has not seen an ensuing drop in gold prices – more evidence that our longstanding axiom on the gold volatility-gold price relationship holds true.
- According to the IG Client Sentiment Index, the gold price rally may not be over, even as traders are remain net-long.
Gold Price Rally Cools, Fundamentals Drivers Remain Bullish
Shortly after the time of our last gold price forecast update, bullion moved to fresh yearly highs and its highest levels since late-2011 (again). But price action has been soft in recent days, not necessarily seeing gold prices fall but the rally come to a stop. The lack of momentum higher, particularly in an environment defined by a sliding US Dollar (the DXY Index is down seven of its past nine days), may be a cause for concern among some traders.
However, the fundamental backdrop for gold prices remains robust. Thanks to expansionary monetary policy and thus far underwhelming fiscal policy responses, mixed with the global economic uncertainty brought about by the coronavirus pandemic, real yields continue to fall and remain depressed. An environment defined by depressed and/or negative real yields has historically proven bullish for precious metals.
A Lesson from The Great Recession
Moreover, it’s worth reflecting on the policy environment in the wake of The Great Recession. Neither gold nor silver prices did well in 2008 or 2009, instead, the bulk of their gains – and the truly impressive stretch of their performance – came in 2010 and 2011. In these two windows (2008 and 2009 versus 2010 and 2011), the Federal Reserve was providing ample monetary policy to markets, and the federal government’s fiscal stimulus response was underwhelming; these are fixed variables.
The main difference between the two periods during The Great Recession is the performance of the economy. The policy conditions were steady – expansionary monetary policy alongside a meager fiscal policy response, leading to low and stable short-term interest rates – but the economy was vastly improved in the 2010 and 2011 period relative to the 2008 and 2009 period.
The result was that while both periods experienced low interest rates, only the latter experienced higher growth and inflation, both actual and expected. It was the expectation for a better economy – higher growth, higher inflation – against a backdrop of expansionary monetary policy that fueled negative real yields.
Does the Future Shine for Gold and Silver? Brightly, Perhaps
Putting this all together, it’s important to think about The Great Lockdown (one of the colloquialisms used to describe the current economic malaise) to The Great Recession. Like then, the Federal Reserve has responded with expansionary monetary policy.
Unlike then, the federal government’s fiscal policy response has proven extremely robust. Rising federal deficits typically fuel inflation expectations as well as higher interest rates; but with the Federal Reserve keeping its main rate tethered near zero through 2022, we may very well be stuck with a net-result of the enhanced fiscal stimulus being higher inflation, but not higher interest rates.
These factors will only enhance the negative real yield argument that has been fueling gold and silver’s rallies in recent months.
You can read more about the impact of negative real yields more in a prior gold price forecast.
Gold Volatility Plunges, Gold Prices Don’t Care
As we’ve noted previously, “given the current environment, falling gold volatility is not necessarily a negative development for gold prices, whereas rising gold volatility has almost always proved bullish; in the same vein, gold volatility simply trending sideways is more positive than negative for gold prices.” This axiom still holds, particularly in light of recent market developments.
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 15.87, now less than 20% of the absolute high set in mid-March near 85.50. It’s worth noting that gold volatility hasn’t traded higher than 23.04 in six weeks; the levels reached in recent days are the lowest since the third week of February when gold prices were trading near 1635 (gold prices traded above 1807 at the time this report was written.
Following a period where gold prices have traded sideways and gold volatility has dropped, the 5-day correlation between GVZ and gold prices is -0.67 while the 20-day correlation is -0.61; one week ago, on July 8, the 5-day correlation was -0.54 and the 20-day correlation was 0.49; and four weeks ago, on June 17, the 5-day correlation was 0.11 and the 20-day correlation was 0.43.
Read more: How Do Politics and Central Banks Impact FX Markets?
GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2008 to July 2020) (Chart 1)
A reminder: gold prices have a relationship with volatility unlike other asset classes, even including precious metals like silver which have more significant 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. Now that there are plenty of signs that no V-shaped economic recovery will occur, and the Federal Reserve intent on keeping the liquidity spigot open for the foreseeable future, the winds of an inflationary US economic environment are blowing through financial markets.
Gold Price Technical Analysis: Daily Chart (July 2019 to July 2020) (Chart 2)
Following the breakout to new highs after the last gold price forecast update, gold prices have traded sideways. Although the rally has cooled off, that doesn’t mean the technical structure is less bullish. In fact, it appears that a short-term bull flag has been carved out between the July 1 high at 1789.27 and the July 8 high at 1818.09. The measured move is for +/-28.82, calling for a bullish breakout target above resistance at 1846.91 or a bearish breakdown target below support at 1760.45 – the latter of which would constitute a break of the uptrend from the March and June swing lows.
It’s worth noting that this short-term bull flag would look for gold prices to supersede the bullish breakout target from the sideways range carved out between the April 14/2020 high at 1747.72 and the April 21 swing low at 1661.42; was looking for a move up to at least 1821. This short-term bull flag would also see the completion of the inverse head and shoulders pattern that was initiated in Q2’19 (read more below).
For now, support still comes in at the daily 5-EMA, which gold prices have not closed below since breaking out on June 24.
Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (June 2011 to July 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 (July 15, 2020) (Chart 4)
Gold: Retail trader data shows 66.25% of traders are net-long with the ratio of traders long to short at 1.96 to 1. The number of traders net-long is 10.72% lower than yesterday and 3.47% higher from last week, while the number of traders net-short is 10.43% higher than yesterday and 13.21% 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.
--- Written by Christopher Vecchio, CFA, Senior Currency Strategist
