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Gold Prices Turn Higher in Bull Flag as US-China Trade War Tensions Flare

Gold Prices Turn Higher in Bull Flag as US-China Trade War Tensions Flare

2019-10-08 14:20:00
Christopher Vecchio, CFA, Sr. Currency Strategist
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Gold Price Forecast Overview:

  • Typically, during environments where the Japanese Yen does well, precious metals do well too – environments defined by capital’s flight to safety.
  • Precious metals do well during periods of elevated volatility as increased uncertainty boosts the safe haven appeal of gold and silver. To this end, the 5-day correlation between GVZ and gold prices is 0.53, and the 20-day correlation is 0.72.
  • Changes in retail trader positioning suggest that the current spot gold price trend may soon reverse higher despite the fact traders remain net-long.

Looking for longer-term forecasts on Gold and Silver prices? Check out the DailyFX Trading Guides.

The latest swings in global equities and US Treasury yields have largely been a function of developments along the US-China trade war front. Even though American and Chinese officials are meeting this week in Washington, D.C. in order to try and come to terms on a trade deal, early indications suggest that nothing substantive will be achieved.

Traders are shifting capital out of higher yielding, high beta currencies and into the lower yielding, safe haven currencies; the Japanese Yen has been a benefactor. Typically, during environments where the Japanese Yen does well, precious metals do well too – environments defined by capital’s flight to safety.

Flight to Safety Benefits Gold Prices

Unlike other commodities, rather than consumption playing the primary driver for gold and silver prices, saving and disposal are the central factors. By ‘saving and disposal’ we mean reasons like: as a hedge against inflation; a safe haven during times of market duress or geopolitical stress; or as an alternative to fiat currencies during periods of low or negative interest rates. Currently, all these factors are in play.

US TREASURY 10-YEAR YIELD: DAILY TIMEFRAME (JUNE 2016 TO OCTOBER 2019) (CHART 1)

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Since hitting its highest level in five weeks on September 13 at 1.907%, the US Treasury 10-year yield has essentially dropped in a straight line downward. With the prospect of a US-China trade deal looking bleak, the US Treasury 10-year was yielding 1.515%. The decline in US Treasury yields continues to cultivate an environment that is long-term bullish for precious metals.

HOW DO INTEREST RATES IMPACT GOLD PRICES?

The shifts in US Treasury yields around the latest US-China trade war news feeds directly into one of the most important fundamental underpinnings of precious metals’ rallies: environments that produce falling real yields tend to be the most bullish.

Real yields are inflation-adjusted yields: in this case, the US Treasury 10-year yield minus the headline inflation rate. Why does this matter? Investing is all about asset allocation and risk-adjusted returns. On the asset allocation side, it’s about achieving required returns given the investor’s wants and needs.

If inflation expectations are rapidly increasing, you would expect to see fixed income underperform: the returns are fixed, after all. Why would you want to have a fixed return when prices are increasing? On a real basis, your returns would be lower than otherwise intended.

Falling US real yields means that the spread between Treasury yields and inflation rates is decreasing. If precious metals yield nothing (no dividends, coupons, or cash flows), they would be more favorable to hold when US real yields fell.

Gold Prices Boosted by Rising Gold Volatility

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) has continued to trade sideways after its late-September spike, moving to 16.11 at the time this report was written. Gold volatility remains below its 2019 high (and highest closing level since December 2017) set on August 15 at 18.72.

GVZ (Gold Volatility) Technical Analysis: Daily Price Chart (November 2016 to October 2019) (Chart 2)

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While other asset classes 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 US-China trade war or the prospect of a no-deal, hard Brexit, for example) increases the safe haven appeal of gold and silver. The 5-day correlation between GVZ and gold prices is 0.53, and the 20-day correlation is 0.72; four weeks ago, on September 6, the 5-day correlation was 0.96 and the 20-day correlation was 0.57.

Gold Price Technical Analysis: Daily Chart - Bull Flag/Descending Channel (October 2018 to October 2019) (Chart 3)

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In our last gold price technical forecast updated, it was noted that “gold prices bottomed out [last] week at 1458.97 and returned above the prospective neckline of the short-term head and shoulders pattern at 1479.73…the bull flag perspective has become the focal point.”

To this end, the gold price bull flag continues to be the predominant price pattern monitored at present time. Gold prices are above the daily 8-, 13-, and 21-EMA envelope, which are aligning in bullish sequential order. Daily MACD is turn higher right at the signal line, while Slow Stochastics have trended higher into bullish territory.

It thus still holds that “If the bull flag in gold prices is legitimate, a break above the late-September swing high at 1538.58 would need to be achieved. In doing so, gold prices would also retake the uptrend from the May and August 2019 lows. The 100% extension of the move from the May low, the September high, and the October low calls for a target price of 1726.31.”

Gold Price Technical Analysis: Weekly Chart – Inverse Head and Shoulders Pattern (February to October 2019) (Chart 4)

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The longer-term gold price inverse head and shoulders pattern initiated in the first half of 2019 remains valid despite the potential for near-term weakness. The placement of the neckline determines the final upside targets in a potential long-term gold price rally: 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 bullish outside engulfing bar low at 1400.38 would draw into question the longer-term bullish potential.

IG Client Sentiment Index: Spot Gold Price Forecast (October 8, 2019) (Chart 5)

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Spot gold: Retail trader data shows 66.2% of traders are net-long with the ratio of traders long to short at 1.96 to 1. The number of traders net-long is 6.3% higher than yesterday and 6.7% lower from last week, while the number of traders net-short is 2.5% lower than yesterday and 1.1% higher from last week.

We typically take a contrarian view to crowd sentiment, and the fact traders are net-long suggests spot 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 spot gold price trend may soon reverse higher despite the fact traders remain net-long.

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Whether you are a new or experienced trader, DailyFX has multiple resources available to help you: an indicator for monitoring trader sentiment; quarterly trading forecasts; analytical and educational webinars held daily; trading guides to help you improve trading performance, and even one for those who are new to FX trading.

--- Written by Christopher Vecchio, CFA, Senior Currency Strategist

To contact Christopher Vecchio, e-mail at [email protected]

Follow him on Twitter at @CVecchioFX

View our long-term forecasts with the DailyFX Trading Guides

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