Gold is trading near all-time highs. On Monday, the June contract for gold climbed as high as $2,049.
Where is gold headed next, and what is the catalyst that could launch it to even greater heights?
Gold is in high demand as central banks are loading up on the yellow metal. For 11 consecutive months central banks have been net buyers of gold, adding 1,136 tons to their stockpiles in 2022.
In February alone, China's central bank, the People's Bank of China, purchased nearly 25 tons of gold. Over the past four months, the PBOC has added 102 tons of gold to its reserves.
This increase in buying activity is reflected on gold's chart. Gold has just broken out of a consolidation pattern known as a bull pennant (black lines). This is a directional pattern that also generates a price target.
Source of charts: TradeStation
In this case, the flagpole of the pattern (points A-B) measures approximately $200 from low to high. To create the price target, add an equivalent amount ($200) to point C, located at the low end of the consolidation area.
Point C is located near $1,950. This means the bull pennant projects gold to reach a price target of $2,150.
What is the catalyst that could launch gold to $2,150? Take a look at the chart of the U.S. Dollar Index ($DXY). The dollar has formed a massive bearish head-and-shoulders pattern over the past year.
According to this chart, the U.S. dollar is on the verge of a decline. If the U.S. Dollar Index falls below 101, additional selling pressure could materialize for the U.S. currency, driving the greenback even lower.
How does a decline in the U.S. dollar affect the price of gold? Here's a simple explanation.
As the U.S. dollar falls, it loses buying power. That means more dollars will be required to purchase any commodity that is valued in dollars. A drop in the greenback would be bullish for stocks, crude oil and precious metals -- including gold.
Because of this inverse relationship between gold and the U.S. dollar, it should come as no surprise that the greenback has formed a bearish pattern at the same time that gold is breaking out of a bullish pattern. If the dollar breaks down, it provides a tailwind for commodities in general.
