Gold Needs More Time To Settle Down

 With the gold market failing to hold any key support at the $1900 level for a third straight session and the brunt of classic fundamental issues favouring the bear camp, the bias is clearly down. Certainly, inflationary conditions remain under the surface but have been shifted to the back burner, especially with equities and consumer sentiment creating anxiety daily.

The war in Ukraine, China’s economic slowdown, rising inflation and volatile stock markets have all conspired to undermine investor confidence so far this year, much to the chagrin of gold dealers in India and bullion dealers in India. After seeing record inflows in 2020, the gold price languished last year and has yet to make a big splash in 2022. The yellow metal did try to breach the $2000 level in early March and once again around ten days back. However, it has been restricted by expectations the US Federal Reserve will now act quite aggressively to bring inflation under control.

Gold has been holding very well above $1900 much to the happiness of gold dealers in India but has seen pressure from the dollar, and the underlying factor of the Fed is expected to raise interest rates by 50 basis points next week. Benchmark 10-year US treasury yields also stabilised, as investors awaited greater clarity on the “restrictive” policy the Fed plans to pursue next week to combat inflation by curbing economic growth. Gold is highly sensitive to rising US short-term interest rates and higher yields, which increase the opportunity cost of holding non-yielding bullion. However, gold is also seen as a safe store of value during economic and political crises.

We all know that when there is a rate hike, gold losses its lustre, making the bullion dealers in India helpless. And once again, the prospect of further US interest rate hikes adds to the relative attraction of the dollar over real assets like gold that have no yield. Fewer dollars are then required to buy an ounce of gold, reducing its dollar price.

Uncertainty over Russia’s next move in the gold market is another reason for caution. Given that a substantial proportion of Russia’s assets have been frozen, there’s always the possibility some of the country’s gold – understood to be worth around $140 billion – could be sold to make payments.

Events that could further derail shares and bonds include interest rate rises having unforeseen knock-on effects in emerging markets, or another outbreak of international tensions, for example, starting in the South China Sea or Iran. With gold prices falling to push higher despite a backdrop of the Ukraine war and rapid inflation, investors have probably decided to look elsewhere.

The inflation levels for March will be released via the PCE by the BEA this Friday, April 29. These two reports will most certainly be underlying forces affecting the upcoming changes in both - the dollar and gold.

It goes without saying that the upside breakaway in the dollar index adds significantly to the bear case, and it could take a very significant development from the war to spark a fresh flight to quality buying. However, a pre-emptive halt in gas exports by Russia to Poland and Bulgaria should rekindle energy price gains, and in turn, could temper current deflationary vibes.

Having said that, the long-awaited big gold rally could still be on its way. The gold price – currently just under $1900 – has, at least, displayed some stability since the turn of the year. So, it may be all that gold needs a bit more time. Poor returns from shares have unsettled investors recently, and any lack of improvement could spark moves into other asset classes.

Is There Much Upside Potential For Gold?

Gold prices touched the $2,000 per ounce level on Monday morning, much to the happiness of the bullion dealers in India - just a couple of weeks after the yellow metal was entering a deep cavern. There were a series of factors stacking up against the long side of the yellow metal, such as the surging interest rates along with a strong reversal earlier in March.

But the shine didn’t last for long. Gold prices gave up all of their gains over the past few days, saddening the bullion dealers in India and also the gold dealers in India. The drop in gold prices now sees the yellow metal trading back below a confluence of former highs carved out between November 2020 and January 2021, which consequently served as resistance as recently as late February and mid-March. Financial markets were in a tart mood in thin trade at the start of the trading week. World over bourses was closed for the Easter Monday holiday, driving down liquidity. That may have contributed to outsized moves, which could then struggle for follow-through as participation levels are rebuilt.

As for the bullish factors, once again, there was a pool of bearish factors that jointly contributed to dampening gold prices -

●       Treasury Yields - Gold Price hit the lowest level in five days at $1,944, as it extended its correction from six-week highs of $1,998 reached earlier this week. The relentless surge in the U.S. Treasury yields on heightening expectations of faster Fed rate increases smashed the non-interest-bearing XAU/USD. The 10-year benchmark yields clocked over three-year highs of 2.95%, while the actual rates turned positive for the first time since 2020. Since the pandemic began, the U.S. 10-year real yield is about to turn positive for the first time. Historically speaking, as discussed in the 2Q’22 quarterly gold forecast, rising real yields have a negative correlation with gold prices. Further advances by the U.S. real yields will only make the environment more difficult for gold prices, particularly if the geopolitical risk premium embedded in price dissipates if the Russian invasion of Ukraine begins to wind down.

●       U.S. Dollar - The greenback ended the day higher against the majority of its peers on Tuesday partly due to a rally in U.S. treasury yields along with the rise in U.S. stocks.

●       Crude Oil - Gold prices remained under pressure in APAC trading after falling through the U.S. session. A drop in oil prices appeared to soften demand for inflation-indexed bonds, pushing real yields higher. That may be a function of increased confidence in the Federal Reserve’s ability to engineer a soft landing through their rate-hiking cycle.

●       Rate Hike - Meanwhile, the 2022 Fed rate hike path implied the steepening of the future interest rates. 225 basis points (bps) in hikes are now priced in for this year, implying that three of the remaining six policy meetings this year will bring an outsized 50bps increase. The rates are typically adjusted in 25bps increments.

●       Chinese GDP Data - The world’s second-largest economy grew 4.8% y/y in the first quarter of this year, topping the forecast calling for a 4.2% expansion. The retail sales fell by a greater-than-expected 3.5% y/y in March amid the renewed Covid lockdowns. However, the unemployment rates rose.

Those factors bode poorly for gold prices. Gold continues to hold its own against the firm U.S. dollar and high bond yields. Remarks made by representatives of the U.S. Federal Reserve do not appear to be having any impact on gold at present. That seemingly leaves gold prices without much upside potential at the moment, a neutral stance, for the time being, maybe the most fundamentally prudent approach.