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Gold Price Forecast: New Highs Beget New Highs - Levels for XAU/USD

Gold Price Forecast: New Highs Beget New Highs - Levels for XAU/USD

2020-08-06 15:15:00
Christopher Vecchio, CFA, Senior Strategist
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Gold Price Forecast Overview:

  • After a brief pause at the end of July, the gold price rally has resumed full steam ahead in August, with fresh all-time highs emerging for each of the past three days.
  • Gold prices continue to shine as the fundamental and technical backdrop remains robust. After all, interest rates will remain low and government stimulus continues to flow, depressing real interest rates.
  • According to theIG Client Sentiment Index, the gold price rally is looking long in the tooth..
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Gold Prices Hit New Highs, Again

After a brief pause at the end of July, the gold price rally has resumed full steam ahead in August, with fresh all-time highs emerging for each of the past three days. The brief round of profit taking at the end of last month has not unmoored the bullish narrative for precious metals, which is robust from both the fundamental and technical perspectives. And while gold’s rally has been impressive, traders would be wise to check out what’s happening in silver prices as well – which are proving stronger than gold prices in recent weeks.

Fundamentals - Solid Like a (Shiny) Rock

Gold prices continue to shine as the fundamental and technical backdrop remains robust. After all, interest rates will remain low and government stimulus continues to flow, depressing real interest rates.

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.

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. Today, the US Treasury 10-year Inflation Protected Securities (TIPS) yield hit an all-time low.

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, which have carried the former to fresh all-time highs and the later to its highest level in over five years.

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 rebound once more following its late-July pullback, which is a positive development for gold prices. 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.”

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.

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)

Gold Price Forecast: New Highs Beget New Highs - 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 26.71, up more than +20% from its low set earlier this week at 21.60. The 5-day correlation between GVZ and gold prices is 0.92 while the 20-day correlation is 0.93; one week ago, on July 23, the 5-day correlation was 0.85 and the 20-day correlation was 0.93.

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

Gold Price Forecast: New Highs Beget New Highs - Levels for XAU/USD

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 July 17, then it would affirm the idea that a near-term top is in place.” To this end, gold prices have not closed below the daily 5-EMA. It is worth noting that the brief pause in price action at the end of July, likely due to end of month portfolio rebalancing flows, did not see the daily 5-EMA broken.

Gold prices have moved beyond 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. Achieving gains through 2053.54, gold prices have advanced through the 123.6% extension, and now are aiming for the 138.2% extension at 2098.77.

Gold Price Technical Analysis: Weekly Chart (June 2011 to August 2020) (Chart 3)

Gold Price Forecast: New Highs Beget New Highs - Levels for XAU/USD

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 “more gains beyond $2000/oz appear increasingly likely, even if there is a near-term setback.” Beyond the 2098.77 level discussed previously in this note, the 123.6% Fibonacci extension of the 2011 high to 2015 low range comes into play at 2127.48, which may be the next place where gold prices take a significant breather.

IG Client Sentiment Index: Gold Price Forecast (August 6, 2020, 2020) (Chart 4)

Gold Price Forecast: New Highs Beget New Highs - Levels for XAU/USD

Gold: Retail trader data shows 67.73% of traders are net-long with the ratio of traders long to short at 2.10 to 1. The number of traders net-long is 10.36% higher than yesterday and 18.64% higher from last week, while the number of traders net-short is 1.37% lower than yesterday and 7.66% 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.

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.

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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.

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