Gold is giving you a once-in-a-generation buying opportunity on its way to 4,400

By Cam Hui

The upside breakout in gold prices has more room to run

Now that gold prices (GC00) are reaching new highs, is there still a buying opportunity - or is this a bull trap?

Let's begin with the reasons for caution. Conventional drivers of gold prices have lagged the yellow metal and are forming negative divergences that warn of excessive frothiness. Should investors be worried about these technical warnings of possible weakness?

Gold traditionally has moved opposite to the U.S. dollar (USD) (DX00). But the dollar's recent weakness doesn't explain why gold is at an all-time high. Gold is also considered a hedge against inflation, yet inflation-linked U.S. Treasury bonds, or TIPS, have been weaker as gold prices have advanced. A similar pattern can be seen in the ProShares Inflation Expectations ETF RINF, which is linked to the price of the FTSE 30-year TIPS Index.

The bull case can be summarized this way: Even as the conventional factors affecting gold prices have stumbled, other factors have emerged to support demand.

In particular, gold prices have soared because central banks have been buying to hedge against geopolitical risk and uncertainty. The most prominent buyers of gold have been Russia and China, in an effort to diversify away from dollar-based assets in case their conflict with the U.S. escalates. Chinese households have also been buying gold. Reuters reported that Chinese buyers are back after a brief two-month hiatus.

In addition, the conventional drivers of gold are also turning up. Central banks are cutting rates as inflation falls. This has the effect of reducing real rates, which is supportive of higher gold prices.

Too frothy?

Western investors have returned to gold, as evidenced by activity in the SPDR Gold Shares ETF GLD. This can be judged bullishly as either as the start of a momentum stampede or in a contrarian bearish fashion as the unsophisticated retail money piling in.

There is no question that gold prices have gone too far, too fast. As SentimenTrader observed in late August: "It's rare to see sentiment toward gold more optimistic than other major markets. April 2020 is the only time in the past decade when sentiment toward gold was higher than that toward stocks, bonds, and crude oil."

On the other hand, my analysis of gold sentiment takes a more nuanced view. The bears will argue that gold mining stocks - using VanEck Gold Miners ETF GDX as a proxy - is overbought and a sign of a frothy market. The bulls will counter that the gold-miner-to-gold ratio is only in the middle of its three-year range. More importantly, junior gold mining stocks - represented by the VanEck Junior Gold Miners ETF GDXJ - are near the bottom of their range against the senior miners, which is hardly a sign of excessive speculation.

Here is my view. My gold-chart analysis indicates a measured objective of $2,826 per ounce, which is a rough indication of gold's potential value over a 12-to-18 month time frame. On a multi-year time frame, the charts point to a measured objective of $4,406 per ounce. Which means that the upside breakout in gold prices has more room to run, though the market currently is extended and could pull back at any time.

Cam Hui writes the investment blog Humble Student of the Markets, where this article first appeared. He is a former equity portfolio manager and sell-side analyst.

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-Cam Hui

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09-21-24 1216ET

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