Gold faces challenges amidst the backdrop of rising real yields

For now, the direction of gold continues to be dictated by movements in the dollar (as seen below) and developments in the short-term interest rate market where traders place bets on the direction of Fed Funds rates and those bets are currently pricing in one full 25 bps rate hike by November before the attention turns to rate cuts with the first now priced in for March next year. As such, it is not a forecast that should trigger the kind of negative response currently seen in gold, and it highlights the fact the market fear more hikes have yet to be priced in. Especially if inflation does not fall at a pace acceptable by the FOMC.

While the short-term technical outlook may deteriorate further on a break below $1900, the next key US economic print will be Friday’s PCE (Personal Consumption Expenditure) deflator, the Fed’s preferred inflation measure. The headline is expected to show a price-supportive drop to 3.8% from 4.4% last month, but with core inflation expected to show continued stickiness at an unchanged 4.7%.

While the short-term outlook remains challenged by the Fed’s prolonged battle with inflation, we keep an overall bullish outlook for gold, driven among others by the following expectations:

• Renewed dollar weakness as yield differentials continue to narrow.
• An eventual peak in Fed rates have historically provided some strong tailwind to gold in the months and quarters that follow
• Central bank demand look set to continue as the de-dollarization focus continues to attract demand from several central banks. One unknown is how price sensitive, if at all, this demand will be. We suspect it will be limited, with higher prices not necessarily preventing continued accumulation.
• We believe inflation is going to be much stickier with market expectations for a drop back below 2.5% perhaps being met in the short-term but not in the long-term, forcing a gold supportive repricing of real yields lower.
• A multipolar world raising the geopolitical temperature
• Low investor participation, recently reduced further, adding support should the above-mentioned drivers eventually supply the expected breakout.

From a technical perspective, gold stays in short-term downtrend following the break below earlier support around $1934. Next key area to watch is around $1900 with $1903 being the 0.618 retracement of the March to May 258 dollar rally while $1902 represents the 0.382 retracement of the whole move up from the November triple bottom low. For the technical outlook to deteriorate further, thereby raising doubt about our overall bullish outlook, the price needs to break back below the February low at $1805. A close above the 21-day moving average, currently at $1945 would be the sign of a change towards a more price favourable sentiment.