Should we buy gold in anticipation of a new high

Key points:

• Gold futures closed within 1.5% of a 2-year high for the first time in over two years
• After similar conditions, gold showed a strong tendency to close at a new high and rally further
• An inverted yield curve should help the case for a bullish breakout

A potential breakout worth monitoring

Gold futures bottomed last fall around the same time as the stock market, coinciding with a Dollar Index peak. The easing in the dollar loosened financial conditions, which has benefitted both asset classes.

When the turmoil in the banking sector flared up a month ago, gold screamed to the upside, and stocks tanked. 

The surge in gold pushed the shiny metal to within 1.5% of a 2-year year high. With gold building a multi-year base, the commodity could be on the verge of a significant breakout.

Similar potential breakout signals were bullish for Gold futures

When gold futures close within 1.5% of a 2-year high for the first time in two years, the commodity tends to breakout and rally with a fairly consistent upward bias across all time frames. 

The February 2019 signal is the only instance that did not close at a new 2-year high within ten trading days. It eventually registered a new multi-year high on 2019-06-20. 

The potential breakout signal led to favorable results for the Gold BUGS Index (HUI), a basket of gold stock companies that hedge their production no more than 18 months in advance. However, in comparing the two options, a gold ETF like GLD looks like a better risk/reward. 

Gold stocks can sometimes be at the mercy of the broad market. 

Silver futures tends to rally after the gold signal. Still, similar to the Gold BUGS Index, the results are not as impressive as holding an allocation to gold.

A bullish macro environment for gold

The potential for a breakout and extension of the current rally looks more favorable with an inverted yield curve. Annual returns for gold futures are significantly better when the curve is inverted.

What the research tells us...

Gold futures are on the cusp of a significant breakout after basing for more than two years. When the commodity closes within 1.5% of a 2-year high for the first time in over two years, gold recorded a new high within ten days in 9 out of 10 cases. The one holdout eventually closed at a new high about four months later. The potential breakout bodes well for a continuation of the current rally, especially with an inverted yield curve.