Gold Price Analysis: XAU/USD remains vulnerable to downside extension

The price of gold, measured by XAU/USD and which fell shy of the $1,800 psychological level by just 0.76%, or $13.50, has been under pressure to start the new month.

A risk-on setting as the USD crumbles and investors remain optimistic into the new quarter is weighing on the safe-haven asset. 

The short-term reallocation of positioning in portfolios is a critical factor for gold prices. The correlation to stocks is compelling today also as the S&P500 rallies over 0.6% to start the month so far. 

With month-end pressures now behind us on a holiday-shortened week, there is going to be a focus on global economic data. 

To start us off, we have had a series of key events today alone, from the US ISM manufacturing release and the June FOMC minutes, as well as the ADP report.

Then, this Thursday's (early) US Nonfarm Payrolls report will be a very important event for the US dollar and gold prices. 

The first risk-on reaction today came from economic activity in the US' manufacturing sector, boosting wider risk sentiment and weighing on both the US dollar and gold prices.

prior to the release, the ADP reported an increase of 2.369 million private-sector jobs in June, below expectations, although this was shrugged off by markets, more aligned in anticipation of the NFP report. 

However, June's ISM's Manufacturing Purchasing Managers' Index (PMI) was improving to 52.6 from 43.1 in May. The reading came in better than the market expectation of 49.5.

Then came the minutes of the Federal Reserve June meeting.

"Although the rates implied by federal funds futures contracts settling next year had fallen to slightly negative levels in May, survey respondents attached very little probability to the possibility of negative policy rates," the Minutes of June meeting showed on Wednesday.

• FOMC Minutes: Negative interest rates not an attractive policy tool

However, what traders are weighing is more than just hopes of an economic recovery.

Inflation expectations are probably going to be the biggest driver for gold prices at this juncture, so long as the slowing growth in new coronavirus cases worldwide.

Eyes on inflation expectations 

"Fauci's dire warning on the virus' path — noting that the nation could see 100,000 new cases day without a change in individual behaviour — could also limit confidence in the economic recovery, challenging the rise in long-term inflation expectations," analysts st TD Securities warned. 

In this respect, the virus presents the most risk to rising long-term breakevens, which have been a powerful driver supporting gold prices.

On the other hand, looking forward, the analysts, however, note, "the entire maturity spectrum of inflation breakevens," (the breakeven inflation rate is a market-based measure of expected inflation)", "are still priced below policy objectives. In this context, declining real rates should imminently support gold prices into the $1800s."

XAU/USD break of support structure speaks volumes

However, the technical picture is starkly different to such optimism as outlined above. 

The price action of late has seen prices fall out of a rising wedge formation which in its self is bearish. 

Then, when measuring the recent highs against the drop in the Chaikin Money Flow on the hourly time frame, such divergence shouldn't be ignored. An expansion of volume on the support line break today can be taken as bearish confirmation.

On the hourly time frame, we have seen a 38.2% Fibonacci retracement. Some bearish consolidation can be expected at this juncture to form the right-hand shoulder (RHS) of the head and shoulder, (H&S) ahead of the next impulse to the downside towards the 1750s and then the 1730s.

On the other hand, should fundamentals flip significantly in the bulls favour and override the technical outlook, the 1800s will be a magnet.