Gold

A gold traders playbook - a very lively December awaits

Chris Weston
Head of Research
15 Nov 2022

Gold (XAUUSD) remains one of, if not the most, traded instrument at Pepperstone and with momentum firm many are asking if the yellow metal can take out $1800, but go on to have a far more prosperous 2023.

Technically, after finding solid bids into $1620 and a solid platform to progress, we’ve seen price breaking the bear channel drawn from the March high – bulls have accelerated their buying through the 5 Oct swing and while ST overbought - as highlighted by price moving to a 2.8% premium to its 5-day EMA – we’re seeing signs of consolidation, before a potential test of $1800/04 and beyond. Happy to hold a positive bias but would reconsider through $1739 and $1710.  

Gold Daily chart

In some sense, it’s been a frustrating year for gold investors, and there has been an opportunity cost with holding longs, especially as cash has emerged as a risk-free investment class. For short-term traders, predictions play less of a role and what’s important is the trading environment on a day-to-day basis – for that, we look at the persistency of trend, frequency of choppy price action and the expansion/contraction in the daily trading range

In 2022 XAUUSD has averaged a daily high-low range of $22, which is in line with the ranges seen in 2021, with the max being $96 (24 Feb 2023) and the minimum $9 (5 Sept) – while this seems low, when you apply leverage there is plenty to work with intraday - but again that depends on one’s strategy.

Favourable trading conditions for short-term traders

The interesting factor is that the 5-day average XAU high-low range currently sits at $30, having dropped a touch from $38 last week – that was the highest 5-day trading average range since June – we also see 30-day realised volatility rising into 20% and not far from the highest of the year. So, as price grinds higher we also see range expansion – favourable trading conditions for the day and swing traders.

A very lively December expected for gold

Looking forward, we see that implied volatility (priced in the options market) has come off a bit, with XAU 1-month IV into 15.5%, but this seems fitting with implied volatility across asset class falling recently. This measure of gold’s expected volatility does take into consideration the US JOLTS job openings report (1 Dec AEDT), US non-farm payrolls (3 Dec) and Nov US CPI inflation report (14 Dec) but is yet to fully incorporate the December FOMC meeting (15 Dec). Either way, while the market pares back expectations of volatility, I do see a floor in vol given this upcoming tier1 event risk and I expect this period to get very lively for gold - as it will the USD, rates and the NAS100.

(Gold vs US 5yr real rates/inverted)

One of the key drivers of XAU is US 5-year real rates – these are US 5yr Treasuries adjusted for expected inflation over the coming five years. You can create this instrument on TradingView by inputting the code – (US05Y – T5YIE) – into the search/navigation bar.

Since hitting $2070 in March, gold tracked US 5-year real rates closely, with the 20-day rolling correlation (by value) hitting 94% in late September – interestingly, while US real rates have rolled down to 1.5%, XAU has significantly outperformed this move in real rates and a simple overlap of the two variables suggests if this relationship was 100% (which of course it isn’t) then XAU should be c. $400 lower.

Given gold’s rise vs US real rates, we can see it’s the USD that is the key determinant and with the wild selling activity taking the DXY below 106, XAU has benefited. One can write a lengthy thesis on the USD, but under the USD ‘smile’ theory, a better feel on global growth is certainly helping, notably with USDCNH coming off so aggressively as China pivots on its Covid plans – we can also see an end to the Fed’s hiking cycle, with many feeling that March 2023 could be the date when we get a prolonged pause in its hiking plans.  

A gold positive - The Fed to pause its hiking in Q123

The next US CPI print (14 Dec) will be a blockbuster – not just because we get the FOMC meeting the day after, but it could confirm that the US inflation rate may be falling not specifically because of tighter financial conditions through QT and rate hikes, and that still need to feed through the real economy. But there is a belief that while supply chains are easing, high prices are feeding on themselves, and inflation is falling on more organic factors – high prices being the cure for high prices – a factor which could be confirmed in Nov US CPI report, and that could radically increase the need to pause on hikes after we see a 50bp in the December FOMC – a gold positive.

I think as we head into year-end, we’ll see the correlation with XAU and the NAS100 increase – of course, both move at a different pace, but the dynamics of USD weakness and lower real rates are a shared factor.

Positioning in gold futures is net short and options skew is neutral – we head into a seasonally strong time to be long US equities and if equities do run hot into year-end, funds will remove USD hedges, and this should boost XAU. An open mind pays, and clearly, if the Nov CPI print comes in hot then gold could get slammed but that is weeks away.

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