(Kitco News) – The gold rally that has pushed the yellow metal to consecutive record highs in recent months is currently on pause as market conditions suggest overly optimistic expectations from traders, but according to one analyst, the current pullback is a welcome sight, and soon, it will serve as a springboard for the next upward movement.
“With the breakout above the resistance zone between USD 2,520 and 2,535, the gold price was able to ignite the next stage of its two-year rally on September 12th,” noted Florian Grummes, managing director of Midas Touch Consulting. “Prices quickly shot up to a new all-time high of USD 2,685 by September 26th. Since the end of June alone, the gold price has thus gained around USD 400.”
“However, over the past three weeks, the gold market initially entered a volatile consolidation phase at a high level,” he said. “With the pullback to a low of USD 2,605 on Tuesday of [last] week, the bears were temporarily able to make an appearance again. However, the psychological mark of USD 2,600 was easily defended, resulting in a significant recovery to USD 2,661 by Friday.”
Grummes pointed to the combination of the first U.S. interest rate cut, a weaker U.S. dollar, and increasing geopolitical escalations in the Middle East as the source of the strong rally in the gold market.
“The overbought situation and weaker-than-hoped-for stimulus packages in China temporarily caused the healthy pullback during the week,” he said. “Furthermore, there had been no substantial price correction since August. In this respect, the pullback has at least released some hot air.”
While gold saw a surge on Friday that pushed it from $2,635/oz to $2,660/oz, Grummes warned that “a direct continuation of the rally is not yet certain. To do so, the gold price would need to break through the three-month downtrend and overcome the USD 2,660 mark. Subsequently, it would be crucial to surpass the recently reached all-time high of USD 2,685. Only when these technical hurdles are cleared could one speak of a resumption of the uptrend.”
XAU/USD Chart by TradingView
“After gold had reached our first major price target of USD 2,535 in mid-August, a sideways consolidation followed between USD 2,470 and USD 2,530,” he said. “Within this four-week breather, however, it soon became clear that gold wanted to move higher, and thus a new breakout was only a matter of time.”
“With the sustained rise above USD 2,530, the next upward thrust began on September 12th, which caused the gold price to virtually explode to USD 2,685 within just two weeks,” he added. “Here, however, the vigorous rally bounced off the upper edge of the superordinate uptrend channel in textbook fashion, and gold slid about USD 80 lower overall in the last three weeks.”
“Nevertheless, this pullback has not led to a sell signal in the weekly stochastic so far,” Grummes said. “Rather, the oscillator sits firmly in the saddle with both lines above 80, bullishly embedded, and has continued to secure the higher-order uptrend. Hence, should the pullback extend, this will likely be played out primarily over time rather than price once again.”
From a weekly perspective, Grummes said the outlook remains bullish. “In the very best case, the pullback is already over. Alternatively, a multi-week consolidation could bring a bottom in the range between USD 2,585 and USD 2,550. At the latest, a broad and very strong support zone awaits between USD 2,530 and USD 2,470.”
Looking at the daily chart, he noted that bears took control over the course of last week.
“The stochastic confirmed this with a clear sell signal,” he said. “However, the significant recovery on Friday has already pushed the bears back into a corner. Given the strong upward momentum of recent weeks and months, new buyers are quickly entering the market even at relatively modest pullbacks.”
That said, he noted that it remains to be seen whether the stochastic oscillator can reach its oversold zone. “In any case, this would require a continuation of the consolidation or pullback,” he said. “With more time and lower prices, a possible ideal target would be the rapidly rising, but still relatively distant 50-day moving average line (USD 2,545).”
If bulls fail to push back above Friday’s high of $2,661 and rally above the all-time high of $2,685 in the near future, Grummes warned, “the breather could play out within the flat downward trend channel in the form of a bullish consolidation flag. In this case, the remaining downside risk would likely be limited to prices between USD 2,590 and USD 2,610.”
“In sum, the daily chart is neutral,” he said. “While the stochastic oscillator still indicates more need for correction, Friday’s recovery has forced a stalemate. If the potential flag formation persists, the rally could resume soon. Alternatively, the 50-day line would be preferable as the target of the pullback. The daily chart calls for patience.”
According to derivatives data, the bearish case for the near future is more likely, Grummes noted, as commercial traders held a cumulative short position of 303,976 gold futures contracts as of the closing price of $2,622 on Tuesday, October 8.
Commitments of Traders (COT) for gold as of October 12th, 2024. Source: Sentimentrader
“This indicates a further deterioration of the situation in the futures market, as professionals apparently see a very high need for hedging,” he said. “Overall, the Commitment of Traders report is extremely negative and clearly bearish. Significantly lower gold prices would be needed before this component of our analysis could be interpreted as neutral or even counter-cyclically bullish.”
He also highlighted that the “OPTIX sentiment index for the gold market measures 77 out of 100 points, indicating a significantly exaggerated optimism level.”
Sentiment Optix for gold as of October 12th, 2024. Source: Sentimentrader
“At the end of September, peak values of 84 were even measured,” he said. “However, when the vast majority of market participants reach a consensus, they are usually wrong. After gold prices have risen by over 66% in the last two years, everyone is now extremely optimistic. As a result, a clear need for correction has built up in sentiment.”
“In sum, optimism in the gold market is currently strongly exaggerated,” Grummes said. “Ideally, a sharp and significant price pullback would lead to a sentiment cleansing, allowing the overarching rally to continue afterwards and potentially maintain strength until next spring.”
The seasonality for gold also suggests bearishness in the short term, as “over the last 15 years, gold has typically corrected between mid-October and mid-December,” he added.
Seasonality for gold over the last 15-years as of May 6th, 2024. Source: Seasonax
“However, based on the last 56 years, the final three months of a year were characterized more by price increases,” Grummes noted. “Given that the world, and consequently the gold market, has changed significantly over the past two decades, we prefer the dataset of the last 15 years. Therefore, the seasonal component for the next two months should be interpreted negatively. Overall, the seasonality tends to point downward until the last Fed meeting of the year on December 17th and 18th.”
And while gold purchases by the People’s Bank of China have slowed in recent months after being one of the main drivers in the yellow metals rise to a new record high, Grummes said, “There are still compelling arguments that [China] will remain an important demander in the medium to long term.”
“Moreover, central banks of emerging markets, in particular, are likely to use any somewhat larger gold price pullback for purchases,” he said. “On top of that, small investors in the US (Costco) and Asia are storming gold dealers. The positive dynamics in the precious metals sector are therefore likely to continue despite occasional breathers and increased volatility.”
“The gradual return of Western institutional investors to the precious metals sector is also expected to lead to a further increase in demand in the coming months,” he added. “The gold holdings of Western ETFs have only been slowly increasing since spring and have a lot of catching up to do. This development could further strengthen the precious metals market and contribute to the medium-term expected upward movement towards 3,000 USD.”
“The overall rally remains intact, but a somewhat extended pause should not be surprising,” Grummes said. “In a slightly more cautious scenario, therefore, the coming weeks could see a healthy reunion with the rapidly rising 50-day moving average line (USD 2,545). This could at least somewhat cleanse the overly optimistic sentiment values.”
“Alternatively, the bulls could use Friday’s recovery to push the gold price further upward,” he added. “The bullish flag would thus be resolved upward soon, and the rally would likely continue more intensely. The next short-term price targets await around USD 2,700 and USD 2,745.”
“Either way, the pullback should serve as a springboard for the next upward movement,” Grummes concluded. “However, in this environment of a strongly advancing gold price, we instead prefer the sometimes still blatantly undervalued silver mining stocks as well as platinum, which has not yet gotten into gear at all.”
At the time of writing, spot gold trades at $2,648/oz for a decrease of 0.33% on the session.
