Gold Daily Timeframe Source: Bloomberg, PSR
After months of trying to break above the $1360 resistance area, the bears emerged victorious in April and kickstarted the current leg of selling. Gold has been falling for the past four months and has erased around -10% from the $1360 high in April. Nonetheless, we are expecting the selling momentum to fade away soon for the bulls to retake control.
On the price action front, the heavy selling since April has taken Gold down to a key support area, between $1215 and $1200 psychological round numbers. Keep in mind the $1215 to $1200 support area is a pivotal point back in May 2016 and February 2017 as it succeeded in halting the selloff and subsequently lifted Gold back into the uptrend with +14% and 13% rally respectively. The current test of the $1215 support area shows a promising sign that the bulls are still present at this key support area. There were two days where price tested the $1215 support area and the bulls relentlessly halted the selling pressure each time. As a result, price formed hammer rejection bar off the $1215 support area on 19 and 20 July 2018 signalling a reversal higher.
Moreover, the Relative Strength Index (RSI) further substantiates for a reversal higher with the current oversold condition. The strong bearish momentum for the past four months has dragged the RSI into oversold condition since 20 June with the RSI hitting an extreme low of 22 on 28 June 2018 suggesting for a mean reversion higher next. RSI measures momentum. A reading above 70 represents overbought condition while a reading below 30 represents oversold condition.
With the recent hammer rejections off the $1215 support area, the RSI managed to recover back above the 30 oversold line suggests the possibility of the beginning of a mean reversion higher. Our 10-year historical study of the oversold RSI mean reversion pattern shows an average rebound of +6% when the signal is triggered, when the RSI rises back above the 30 oversold line. Hence, if the current bullish rejection off the $1215 support area ushers in the oversold RSI mean reversion, expect Gold to rally +6% in the near-term to test the $1300 psychological round number.
Bear in mind there was a failed oversold RSI mean reversion signal recently in July as the rebound was rather shallow shown by the red highlighted area. However, with that failed signal, price is setting up for an RSI Bullish Divergence signal. Instead of seeing a Lower Low in the RSI, it has formed a Higher Low on 19 July 2018 with the recent bullish rejection off the $1215 support area shown by the diagonal lines. This is contrary to what Gold price is doing with the formation of the Lower Low. Therefore, if the hammer rejection bar were to hold, the Bullish Divergence pattern should play out suggesting the start of a bigger move higher.
From the speculators positioning perspective, the current market dynamics are also supportive of a move higher in Gold due to the unloved sentiment. The current net speculator positioning stands at 57,841 contracts which is considered extremely low from a historical perspective. The last time we saw such a hated attitude towards Gold was in July 2017. The subsequent move in Gold was a sharp reversal higher by +7%, from $1268 to $1357. Historically, the net speculator positioning provides a good contrarian signal when the herd are heavily tilted on the long or short side. Thus, whenever, the net speculator positioning enters into the extreme ends, a mean reversion tends to happen, and a similar reversal move in Gold. Thus, expect the mean reversion to happen soon as the net speculators are once again extremely disinterested to Gold.
In summary, expect the key support area at $1215 to $1200 area to hold for the long-term uptrend to resume. The current hammer rejection off the $1215 support area with RSI bullish divergence suggests a rebound higher next for Gold to retest the $1260 resistance area followed by $1300.