XAU/USD Forecast: Inflation and Excess Liquidity to Keep Gold Supported in the Long-Term

Key Talking Points:

• Gold faces a tighter range after the significant drops caused by vaccine news
• Low interest rates and increased money supply paint a bullish case for Gold
• Long positions continue to fall

Gold was in for another day of two-way trading yesterday but remained trapped below $1900 in what seems to be a new short-term range. The yellow metal has been range-bound since the beginning of September, when bulls failed to push the price above 2000, keeping its price subdued towards the lower-bound of the range, found at 1848.

But after a significant drop on Pfizer Monday, which saw gold plummet more than 5.5% during the trading session, the precious metal now seems to be trapped in a tighter range, with limited gains above the 1900 mark, a significant psychological area that has now converged with a bearish cross of the 20-day simple moving average below the 50-day average.

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At this point it seems that a defensive US Dollar on continued rising infections is the main driver of XAU/USD short-term weakness, although wider macroeconomic factors are largely at play. The main focus being on risk-sentiment, and defensive buying. Bond yields, which are thought to be a good gauge of investor sentiment, are inversely related to the price of gold, pointing to its value as somewhat of a safe-haven, as returns on other assets are diminished. And real yields, those of inflation-linked bonds, have been the center of attention for some months, particularly as XAU/USD was hitting an all-time high back in August.

GOLD PRICE AND BOND YIELD RELATIONSHIP

But bond yields have since started to pick up, as sentiment has improved and investors are left searching for greater returns on their capital, which has of course had a diminishing effect on gold. The question now is, will gold continue to head lower as real yields pick up on improving economic conditions, or is looser monetary policy still enough to keep the yellow metal interesting? We must keep in mind that if interest rates stay low as the Fed has indicated, the opportunity cost of holding gold — a non-yielding asset — will be quite low, because investors are not foregoing interest that would be otherwise earned in yielding assets.

This would in turn keep gold prices higher, as well as an increased money supply in the economy. Which is another important factor in the pricing of precious metals, as when more money is available, their prices will be higher in terms of paper money, which could suggest viewing gold as a measure of financial liquidity.

So based on liquidity alone, we could expect gold to be hitting all-time highs by the end of the year, continuing a positive trend as, and when, inflation starts to pick up. Because betting against gold would be like betting that central banks are going to reverse their current policies, shortening liquidity and leading to rate hikes.

But near term direction seems to be tilted to the downside, as gold struggles to generate meaningful momentum to push higher amid the noise of vaccine and infection headlines.

Spot XAU/USDHourlyChart (16 October – 19 November 2020)

Looking at an hourly chart, XAU/USD is now trading below its four main moving averages, breaking to the downside a short-term rising channel. Further downside would need to hold above 1848 to avoid further damage, but critical support levels look like they could be broken, at which point selling pressure is likely to increase towards the 1800 mark, where gold price was trading comfortably before the surge in July and August. On the flip side, a sustained break above 1900 is needed in order to start considering it a change in price action.

LONG POSITIONS CONTINUE TO FALL

The latest Commitment of Traders (COT) report shows that, despite there not being a material change in short positions in gold amongst money managers, long positions have fallen by for a third consecutive week, reaching its lowest level since May 2019, whilst bearish positions remain at their strongest since June 2019.

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— Written by Daniela Sabin Hathorn, Market Analyst

Follow Daniela on Twitter @HathornSabin