Gold Price Forecast: Breakout Reaches Major Target - Levels for XAU/USD

GOLD STARTS THE NEW YEAR WITH A BANG

At the end of December, in our last gold forecast of 2019, the following observation was made: “is the current market environment another ‘canary in the coal mine’ for gold prices? The resiliency of gold prices can’t be ignored, even during the upcoming illiquid holiday trading period.”

Regardless on the specific catalyst – in this case, rising geopolitical tensions between the US and Iran -- over the past two weeks, gold prices have exploded higher. And while both the fundamental and technical backdrops remain supportive of higher gold prices, it’s important for traders to appreciate how quickly gold prices have rallied in a key long-term target in the multi-year bottom effort.

GOLD VOLATILITY’S SURGE HELPS LIFT GOLD PRICES

Precious metals like gold 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, etc. – precious metals tend to benefit during periods of higher volatility.

Heightened uncertainty in financial markets due to increasing macroeconomic tensions (like the major escalation in geopolitical tensions between the US and Iran) increases the safe haven appeal of gold. On the other hand, decreased volatility tends to harm gold prices.

GVZ (GOLD VOLATILITY) TECHNICAL ANALYSIS: DAILY PRICE CHART (DECEMBER 2016 TO JANUARY 2020) (CHART 1)

In the last gold forecast update, it was noted that “gold volatility has moved back towards its yearly lows while gold prices have stayed elevated is an important development that shouldn’t be dismissed.”

Why? Historical context matters greatly: “over the past two years, whenever gold volatility has plunged but gold prices have held their ground, the development typically preceded a rally by gold prices. The rationale being that if an environment defined by low gold volatility isn’t eroding gold price action, then gold’s fundamental underpinning is probably strong than presumed.”

Now, 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 14.03; in our last update on gold volatility at the end of December 2019, GVZ was trading at 9.51. Gold volatility is now back to its highest level since October.

In turn, the correlations between gold prices and gold volatility have eroded: the 5-day correlation between GVZ and gold prices is 0.98 while the 20-day correlation is 0.91; in the prior gold volatility update, the 5-day correlation was 0.22 and the 20-day correlation was -0.09.

GOLD PRICE TECHNICAL ANALYSIS: DAILY CHART - DESCENDING CHANNEL (JANUARY 2019 TO JANUARY 2020) (CHART 2)

In our last gold price forecast, it was noted that “despite the upcoming holiday period into the New Year, traders should be on the lookout for a potential bullish breakout in gold prices. A bullish outlook for gold prices would only be valid if the descending channel from the September and November highs breaks, which would occur above 1475 by the end of 2019.”

The bullish breakout in gold prices indeed transpired in December. Earlier on Monday, January 6, gold prices cleared their 2019 highs near 1556.88, hitting a seven-year high of 1588.15. (More below on why the high is important in the near-term.)

As it stands, gold prices are pushing above the daily 5-, 8-, 13-, and 21-EMA envelope, which is in bullish sequential order. Daily MACD is trending higher, at its highest level in bullish territory since mid-September, while Slow Stochastics are hanging in overbought territory. The path of least resistance remains to the topside for gold prices.

GOLD PRICE TECHNICAL ANALYSIS: WEEKLY CHART – INVERSE HEAD AND SHOULDERS PATTERN (MAY 2011 TO JANUARY 2020) (CHART 3)

The weekly timeframe moves at a glacial pace, although there have been meaningful developments in recent weeks. The gold price rally at the end of 2019 must be viewed in context of the longer-term technical picture: the gold price inverse head and shoulders pattern that originated earlier this year is still valid and guiding gold price action.

Gold prices have achieved the 61.8% retracement of the 2011 high/2015 low range at 1586.71, indeed clearing the level briefly earlier on Monday, January 6. This is further confirmation that a long-term bullish bottoming effort is still in process.

Depending upon the placement of the neckline, the final upside targets in a potential long-term gold price rally vary: conservatively, drawing the neckline breakout against the January 2018 high at 1365.95 calls for a final target at 1685.67; aggressively, drawing the neckline breakout against the August 2013 high at 1433.61 calls for a final target at 1820.99.

Only a break below the August 1, 2019 bullish outside engulfing bar low at 1400.38 would draw into question the longer-term bullish potential for gold prices.

IG CLIENT SENTIMENT INDEX: GOLD PRICE FORECAST (DECEMBER 20, 2019) (CHART 4)

Gold: Retail trader data shows 64.58% of traders are net-long with the ratio of traders long to short at 1.82 to 1. The number of traders net-long is 13.95% higher than yesterday and 0.78% higher from last week, while the number of traders net-short is 1.77% lower than yesterday and 6.60% 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. Positioning is more net-long than yesterday but less net-long from last week. The combination of current sentiment and recent changes gives us a further mixed gold price trading bias.