Is gold headed to new highs or is August’s sell-off anticipating even bigger declines ahead?

Gold prices have had an outstanding run since the financial markets touched bottom on March 23, following the pandemic sell-off that plunged the value of most asset classes amid fears of a global Armageddon caused by the COVID-19 virus.

So far this year, the yellow metal accumulates a 30% gain – an eye-popping return by all measures – although outpaced by silver, which currently accumulates a 53% gain as precious metals have become the go-to asset class for investors seeking to hedge their wealth against a potential surge in inflation.

With central banks around the world injecting trillions into their domestic economies and miners struggling to keep their operations up and running while protecting their employees from the virus, gold prices seem to have the perfect backdrop for a continuous surge.

However, this gold fever had a complicated episode on the first few days of August, as the value of gold in US dollars plunged by more than 7% in just 3 days, in a combination of profit-taking and risk-on moves that plunged the price of the precious metal down to $1,913 per ounce from its 2020 high of $2,068 per ounce.

Now, gold traders and investors are struggling to draft a plausible gold price forecast as they try to understand if this was a temporary pause in the rally or if there’s more downside ahead they should watch out for.

How was gold looking prior to the sell-off?

Gold prices had already stepped on overbought territory based on their Relative Strength Indicator (RSI), which went as high as 90 a couple of weeks before the sell-off.

That said, gold managed to reach its all-time highs by posting a solid higher-high in the RSI, a situation that you would expect to see in a bullish continuation move.

However, the price of the yellow metal was too overextended at that point, trading 25% above the metal’s 200-day moving average – one of the highest historical extensions seen in the price of gold.

Based on those indicators, a sharp sell-off should have been expected, not necessarily because gold’s appeal as an inflation hedge has faded, but primarily for technical reasons – i.e. profit-taking moves, over-heated speculative rally, etc.

A breather was necessary to resume gold’s upward trend, which is still intact, and at this point, the trend continues to be the gold’s trader friend.

That said, it is important to keep in mind that the 1-day MACD line has gone below the signal, which is an indication that gold’s momentum may be weakening, although the indicator remains in positive territory, and should remain there as long as this favorable economic backdrop continues to provide a tailwind for the yellow metal.

Which variables are playing in favor of gold?

Although from a technical perspective there are sufficient grounds to justify a mean-reversion move – possibly towards the short-term trend lines rather than the long-term one – the global economic backdrop continues to play in favor of high gold prices.

The following is a quick summary of some of the elements that are setting a floor for gold prices at the moment:

• Fiat currency debasement

According to data from McKinsey & Company, central banks and governments have injected more than $10 trillion in liquidity into the global markets in response to the financial and economic fallout caused by the pandemic.

The United States’ Federal Reserve is leading the charge in this initiative, followed by China, Japan, and the European Central Bank (ECB), with the bulk of these injections coming in in the form of guarantees and straight-forward cash injections via asset purchases, repos, and credit lines.

For the US dollar, the impact of this expansionary policy has been fairly obvious, as the greenback has lost roughly 10% of its value – as reflected by the US dollar index (DXY) – since reaching its 2020 peak on March 22.

This systematic global debasement of fiat currencies has probably been one of the strongest drivers of this gold surge, as investors have flocked to the precious metal to hedge against the impact that these policies will eventually have on the purchasing power of fiat currencies.

• Increased uncertainty caused by the pandemic

The COVID-19 pandemic has triggered a volatility spike in the financial markets, as reflected by the CBOE SPX Volatility Index – also known as the VIX – which is still trading above its pre-pandemic levels at 21.8, although significantly lower than its 2020 high of nearly 90.

The uncertainty caused by the outbreak, and its subsequent effect in market volatility, has been another element favoring a surge in gold, as the precious metal has been seen as a safe-haven asset for centuries during times of extreme economic and financial turmoil.

• The “TINA” phenomenon

TINA, an acronym for “There Is No Alternative”, is a market sentiment phenomenon that occurs when other available assets fail to provide a set of conditions that investors are currently seeking, which may be the case for gold in an environment such as the one the world is submerged into right now.

For investors who are seeking refuge from the volatility of equities, bonds are no longer the go-to place to pour money in exchange of relatively low yields, as interest rates across the world for investment-grade bonds – both nominal and real – are increasingly dropping to negative territory, leaving investors with few choices as to where they can park their money while the virus-related volatility subsides.

Meanwhile, with unemployment rising to historical levels, rental demand dropping in most developed countries, and mortgage rates pushing the price of properties up, real estate is hardly the “safe” alternative at this point.

In that scenario, gold, despite its natural disadvantage of not producing any income for its holder, emerges as the only alternative to bonds and real estate, providing the safeness of being a hard asset and a historical store of value.

Bottom Line

Although gold prices may go down from the all-time highs they jumped to recently, the economic backdrop continues to favor high gold prices in the near future, at least until central banks pull the breaks on their expansionary moves and the market volatility caused by the virus subsides once and for all.

This article does not necessarily reflect the opinions of the editors or management of EconoTimes