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Gold Price Forecast: False Breakout Potential amid Return to Wedge – Levels for XAU/USD

Gold Price Forecast Overview:

  • Gold prices have struggled through September after being one of the best performing assets since global financial markets bottomed out in March.
  • With expectations for fresh fiscal stimulus low, US inflation expectations have receded, allowing US real yields to turn higher. As a result, the fundamental bedrock of the gold price rally has been tempered.
  • According to the IG Client Sentiment Index, gold prices are on mixed footing.

Gold Prices Drop as US Inflation Falls Short

Gold prices are struggling through the early part of the week, spurred by the latest round of US inflation data. The September US consumer price index showed a slightly reduced pace of price growth than anticipated (+1.7% versus +1.8% expected), suggesting that the US growth recovery may be plateauing. While talks regarding another US fiscal stimulus package are ongoing, and a favorable outcome appears to be priced into markets, today’s inflation data directly impacts the policy feedback loop. Lower inflation readings in context of short-term rates pinned near zero thanks to the Federal Reserve means US real yields rise. If rising real yields proved harmful for gold prices throughout August and September, then another bump in US real yields can be reasonably attributed as the rationale behind the gold price decline.

Gold Prices Remain Decoupled from Gold Volatility

Gold prices have a relationship with volatility unlike other asset classes. While other asset classes like bonds and stocks don’t like increased volatility signaling greater uncertainty around cash flows, dividends, coupon payments, 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.

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (October 2008 to October 2020) (Chart 1)

Gold Price Forecast: False Breakout Potential amid Return to Wedge - Levels for XAU/USD

Gold volatility continues to steady, proving neither a positive nor a negative for gold prices. The atypical state of negative correlations persists. 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 23.00. The 5-day correlation between GVZ and gold prices is -0.34 while the 20-day correlation is -0.76; one week ago, on October 6, the 5-day correlation was -0.43 and the 20-day correlation was -0.84.

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

Gold Price Forecast: False Breakout Potential amid Return to Wedge - Levels for XAU/USD

Gold prices appeared to be finding some bullish resolution after trading for weeks in a falling wedge consolidation since the August high – but that interpretation of price action is being drawn into question at the start of this week. Gold prices have fallen back below the bearish outside engulfing bar high establish on October 6, and in the process, have traded back below the descending trendline from the August and September swing highs.

At present time, gold price momentum is nonexistent. Gold prices are in line with their daily 5-, 8-, 13-, and 21-EMA envelope, which is in neither bearish nor bullish sequential order. Daily MACD is flattening out below its signal line, while Slow Stochastics’ advance towards overbought territory has been stemmed.The previous expectation that “gold prices are about to turn higher in a meaningful way” may be misguided; more clarity is needed.

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

Gold Price Forecast: False Breakout Potential amid Return to Wedge - Levels for XAU/USD

It’s been previously noted that “a loss of the August low at 1862.90 would be a very important development insofar as redefining the recent consolidation as a topping effort rather than a bullish continuation effort. That the August low was retaken and prices have returned back into the sideways range, but moreover, having started to breakout of the bullish falling wedge, suggests that we may be witnessing the early stages of the next leg higher.” Failure to stay above the descending trendline from the August and September swing highs would suggest that the next leg higher is not beginning.

IG Client Sentiment Index: Gold Price Forecast (October 13, 2020) (Chart 4)

Gold Price Forecast: False Breakout Potential amid Return to Wedge - Levels for XAU/USD

Gold: Retail trader data shows 76.64% of traders are net-long with the ratio of traders long to short at 3.28 to 1. The number of traders net-long is 2.86% higher than yesterday and unchanged from last week, while the number of traders net-short is 4.08% lower than yesterday and 8.42% 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