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Gold Price Forecast: After All-Time Highs, Time for Profit Taking? - Levels for XAU/USD

Gold Price Forecast: After All-Time Highs, Time for Profit Taking? - Levels for XAU/USD

Christopher Vecchio, CFA,
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Gold Price Forecast Overview:

  • Gold prices surged to an all-time high this week and long-term technical trends remain bullish. But as the end of the month approaches, the rally may hit pause.
  • The rally in gold prices (and precious metals in general)continues to be supported by a sturdy fundamental base – that real yields will remain low, if not in negative territory for some years to come. The July Fed meeting did little to alter this narrative.
  • According to the IG Client Sentiment Index, gold prices retain a bullish bias.
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Gold Prices Continue to Shine

Gold prices hit a fresh all-time high this week as traders pile into precious metals amid speculation that stimulus – both from central banks and fiscal authorities – will continue for the foreseeable future. The Federal Reserve reinforced that narrative at its July policy meeting, with Fed Chair Jerome Powell indicating that more support is necessary to prevent the US economy from backsliding into the worst economic crisis since The Great Depression – or worse.

Yet, we are at the end of the month. Gold prices have been on a robust run, gaining ground in over 80% of the trading days in July. It may be a good time to take profit, with end of month portfolio rebalancing flows dictating that traders lock-in some of their gains to benchmark a solid performance to start the second half of 2020. Technical indicators suggest that a near-term point of exhaustion may have be reached as well.

The Fundamental Back Drop Remains Strong for Gold Prices

Even if gold prices have hit a near-term point of exhaustion, the longer-term prospect for gold prices (and precious metals generally speaking) continues to hold. Like during The Great Recession, the Federal Reserve has responded with expansionary monetary policy. Unlike during the Great Recession, 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.

Accordingly, the fundamental backdrop for gold prices remains stable. Thanks to expansionary monetary policy and even now enhanced fiscal policy responses real yields continue to fall and remain depressed: short-term rates are stuck near zero while growth and inflation rates are rising. An environment defined by depressed and/or negative real yields has historically proven bullish for precious metals. This week, the US Treasury 10-year Inflation Protected Securities (TIPS).

It still holds that these factors will continue to enhance the negative real yield argument that has been fueling gold and silver’s rallies in recent months, and moreover, the breakout to fresh highs that has unfolded in the second half of July.

You can read more about the impact of negative real yields more in a prior gold price forecast.

Gold Volatility Pulls Back, Sets Stage for Gold Price Rally Pause

Gold volatility has started to pullback, which isn’t necessarily a negative development for gold prices – if our longstanding axiom holds: “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.”

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 24.75, down -20% from its high set earlier this week. Following a period where gold prices hit all-time highs while gold volatility jumped by 50% over a week, the 5-day correlation between GVZ and gold prices is 0.86 while the 20-day correlation is 0.93; one week ago, on July 23, the 5-day correlation was 0.96 and the 20-day correlation was 0.22.

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 – which, by the way, are back in the news thanks to the latest US-China trade war headlines.

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

Gold prices have now achieved the 100% Fibonacci extension of the coronavirus pandemic recovery move, from the March 20 low to the May 18, back to the June 5 low. This measurement comes in at 1980.37; gold prices reached a high of 1981.36 this week before reversing. It still holds that momentum-based analysis is appropriate given the context of the breakout move. If the daily 5-EMA is lost, which gold prices have not closed below since breaking out on June 24, then it would affirm the idea that a near-term top is in place.

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

Gold prices have completed the inverse head and shoulders pattern first identified in mid-2019. Depending upon the placement of the neckline, the final upside target was 1820.99. The long-term gold thesis is now evolving, but with the bottoming effort completed, we can now turn our attention to all-time highs at 1921.07 – and well-beyond over the coming months.

In the last update it was noted that “from this strategist’s perspective, it would be a surprise if gold prices didn’t not see $2000/oz by the end of the year (and even that feels conservative as it is being written).” That was ~5% ago. More gains beyond $2000/oz appear increasingly likely, even if there is a near-term setback.

IG Client Sentiment Index: Gold Price Forecast (July 30, 2020) (Chart 4)

Gold: Retail trader data shows 65.57% of traders are net-long with the ratio of traders long to short at 1.90 to 1. The number of traders net-long is 7.56% lower than yesterday and 5.64% higher from last week, while the number of traders net-short is 1.47% higher than yesterday and 11.40% 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

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