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Gold Price Forecast: Bullish Breakout Beginning? Key Levels for XAU/USD

Gold Price Forecast Overview:

  • Gold prices have been able to maintain their impressive gains during the past several weeks of consolidation. The next leg up may be starting now that the flag/symmetrical triangle is yielding a bullish breakout.
  • Gold volatility has turned higher the past two days, tracking the jump in US equity market volatility as risk appetite has eroded into the middle of May.
  • According to the IG Client Sentiment Index, gold prices may still rally despite traders staying long.
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Gold Prices Weather the Storm, Emerge Unscathed

After hitting a fresh yearly high and their highest level since 2013, gold prices have been trading sideways for the better part of the past month. Despite the fact that the US Dollar (via the DXY Index) has proven resilient and equity markets have rallied higher, gold prices have not budged after their impressive gains during the early stages of the coronavirus pandemic. After all, gold prices are the ultimate hedge against sovereign incompetence.

It is beginning to appear like that ‘the bounce’ in risk appetite is over. Federal Reserve Chair Jerome Powell’s comments yesterday, that more fiscal stimulus is necessary, are falling on deaf ears among fiscal policymakers in Washington, D.C.: US President Donald Trump has said that House Democrats’ latest stimulus proposal is “dead on arrival.”

Despite the worst economic crisis in American history gathering pace with now more than 35 million Americans without work, Congress will bicker and banter without brokering any deal. And so, as sovereign incompetence appears to be on the rise, risk appetite is fading, and gold prices are gaining some room to shine again.

Read more: US Recession Watch, May 2020 – US Yield Curve Hides the Truth

Gold Volatility Edges Up as Equity Volatility Jumps

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. That we’ve witnessed equity volatility (as measured by the VIX) jump in recent days further supports the bullish narrative for gold prices.

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 22.71, still a far cry from the absolute highs set in mid-March near 85.50. It’s been our observation for several weeks that “despite gold volatility breaking its initial coronavirus pandemic lows, gold prices did not follow lower.” It appears that a one-way street has emerged: falling gold volatility is neutral; rising gold volatility is bullish.

As such, the 5-day correlation between GVZ and gold prices is 0.92 while the 20-day correlation is 0.00; one week ago, on May 7, the 5-day correlation was -0.43 and the 20-day correlation was -0.10; and one month ago, on April 9, the 5-day correlation was -0.84 and the 20-day correlation was -0.74.

In our last note, it was observed that “short-term correlations are turning positive again, and gold volatility is starting to edge higher, a gold price breakout may not be far behind.” We may be at this precipice.

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

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The gold price forecast of the past several weeks is intact, and starting to gain traction: “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.”

Price momentum has accelerated in a bullish manner in recent days, with gold prices rising above their daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Daily MACD is nearing a bullish crossover while in bullish territory, while Slow Stochastics have risen through their median line. The conditions are in place for gold prices to rally to fresh 2020 highs.

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 14, 2020) (Chart 4)

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Gold: Retail trader data shows 72.23% of traders are net-long with the ratio of traders long to short at 2.60 to 1. The number of traders net-long is 3.34% lower than yesterday and 1.56% higher from last week, while the number of traders net-short is 17.99% higher than yesterday and 8.96% 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