GOLD : Struggle in September

(Wed, 30 Sept 2020). 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.

After gaining more than +40% from the March low to the August high, gold prices have spent the final weeks of summer and the first week-plus of autumn trading lower: coming into today, gold prices had lost near -4.6% month-to-date, and are down by over -9% since the August high. With the September US nonfarm payrolls report coming into focus this Friday, it’s worth examining the motivation behind gold’s decline.

Real Yields Turn Against Gold

The stronger than expected August US nonfarm payrolls report proved to be an important turning point for markets, insofar as it reduced the likelihood that the Trump administration would cede ground to Congressional Democrats’ demands for another round of fiscal stimulus.

The feedback mechanism follows as such: reduced odds for more fiscal stimulus equate to a reduced pace of deficit spending; a reduced pace of deficit spending reduces inflation expectations; lower inflation expectations in context of short-term rates pinned near zero thanks to the Federal Reserve means US real yields rise. If negative real yields are good for gold prices, then the development of higher real yields has proven to take luster off the gold price rally.

Watch the US Jobs Report on Friday

Another strong US labor market report and expectations for near-term fiscal stimulus could drop further, providing a lift to US real yields and thus sending gold prices lower again. But a weaker US jobs report could stoke speculation that the Trump administration will cede to Congressional Democrats demands for a more robust fiscal spending package, including bolstered unemployment benefits or another one-time distribution to individuals, a potentially politically-appealing prospect for US President Trump ahead of the November elections.

Gold Volatility Coils, Neither Helping nor Hurting

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, 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.

Gold Price Forecast: Losing Luster as Real Yields Turn Higher - Levels for XAU/USD

Gold volatility has shifted lower in recent weeks but has steadied over the past few days, in line with the stability seen in gold prices. As such, there has been a restoration in short-term correlations. 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 22.54. The 5-day correlation between GVZ and gold prices is 0.22 while the 20-day correlation is -0.60; one week ago, on September 23, the 5-day correlation was -0.98 and the 20-day correlation was -0.08.

Gold prices have traded higher in recent days after pushing through the August low, returning back to the sideways range support established from mid-August to late-September between 1901.62 and 2015.73. That said, gold price momentum remains weak, with daily MACD trending lower below its signal line and Slow Stochastics holding in bearish territory (albeit trending higher). With gold prices enmeshed in the daily 5-, 8-, 13-, and 21-EMA envelope, the near-term outlook is muddled and needs more significant price development before a clear bias can be discerned.

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.” The August low has been tested, and indeed a close below developed last week, but we have yet to see significant follow through. That said, it stands to reason that the long-term bullish technical structure has been damaged. Failure to retake the weekly 13-EMA – the quarterly moving average – would be a major warning sign for gold prices.

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