Gold’s short-term outlook challenged by relentless yield surge

Ole Hansen

Head of Commodity Strategy

Summary:  Gold continues to defy the gravitational pull from rising US Treasury yields and a stronger dollar which gathered further momentum after the US Federal Reserve last week delivered a hawkish pause in their aggressive rate hike campaign. But while the normally strong inverse correlation with dollar and yields have faded, thereby reducing selling pressure from algorithmic focused trading strategies, gold's resilience continues to point to demand from investors seeking a hedge against nervous markets and the rising risk of stagflation hitting the US economy in the coming months.

Global Market Quick Take: Europe
Commitments of Traders: Crude oil and gold in demand ahead of FOMC
Macro/FX Watch: Dollar remains bid on yield and safety

Key points in this gold note

  • Gold continues to show resilience despite multiple headwinds from dollar strength to rising yields and lower future rate cut expectations
  • Support is likely to be driven by a market in search for a hedge against the FOMC failing to deliver a soft, as opposed to a hard landing.
  • We maintain a patiently bullish view on investment metals as the timing of a fresh push to the upside remains very US ecnomic data dependent. 

Gold continues to defy the gravitational pull from rising US Treasury yields and a stronger dollar which gathered further momentum after the US Federal Reserve last week delivered a hawkish pause in their aggressive rate hike campaign, while at the same forecasting considerably higher rates over 2024 and 2025 because of a resilient US economy, a strong labor market and sticky inflation, recently made worse by an OPEC-supported rise in energy prices.

Following the FOMC announcement we have seen the dollar reach a fresh 11-month high against a broad basket of major currencies, while the yield on US 10-year Treasuries has reached a 16-year high above 4.5%. The short-term interest rate futures market has reduced bets on the number of 25 basis-point rate cuts by the end of 2024 to less than three from the current level, with risk of another hike before yearend kept open.

Looking at our gold monitor below, it is difficult to build a bullish case for gold if current developments were the only driver for the yellow metal. With the dollar and bond yields on the rise, the inverse correlation with a relatively stable gold has deteriorated, a development that has reduced selling pressures from algorithmic trading strategies, normally a major contributor to daily trading volumes.

In addition, as mentioned the tailwind from future rate cuts has also faded as the market price in a higher for longer scenario. A development which for now continues to see some asset managers vote with their feet when it comes to investing in gold through Exchange-traded funds, the reason being the high opportunity cost of holding a non-interest paying position relative to short-term government bonds. The current cost of holding a gold position for 12 month is close to 6%, the bulk of that being the cost of borrowing dollars for one year, and until we see a clear trend towards lower rates and/or a upside break forcing a response, real money allocators will be looking for opportunities elsewhere.

ETF investors which include the above mentioned group of real money allocators have been cutting holdings for the past four months, leaving the total down by 172.4 tons during this time to 2757.8 tons, a 3-1/2-year low. The leverage fund net long position meanwhile continue to hover around 60k contracts (6 million ounces), some 35k below the one-year average.

As mentioned in previous updates, the reason why gold in our opinion has been holding up well despite the mentioned headwinds, is likely to be a market in search for a hedge against the current negative market sentiment and most importantly, the FOMC failing to deliver a soft, as opposed to a hard landing. A hard landing or stagflation may occur if the Fed keeps the Fed funds rate too high for too long or in the unlikely event the economy becomes too hot to handle. Other drivers can be rising energy prices keeping inflation elevated while hurting economic activity or a financial of geopolitical crisis erupts.

Demand for gold as a hedge against a soft-landing failure is unlikely to go away as the outlook for the US economic outlook in the months ahead looks increasingly challenged. With that in mind, we maintain a patiently bullish view on gold while wondering whether the yellow metal in the short-term will continue to be able to withstand additional yield and dollar strength. The timing for a fresh push to the upside will remain very US economic data dependent as we wait for the FOMC to turn its focus from rate hikes to cuts, and during this time, as seen during the past quarter, we are likely to see continued choppy trade action.

Spot gold, in a downward trending channel since May, is currently stuck in a $1900 to $1950 range with additional dollars and yield strength raising the risk of a short-term break below which may see $1885 being challenged. A close back above the 200-day moving average, last at $1927, is likely to coincide with a break of the mention downtrend, opening for a fresh attempt to challenge resistance in the $1950 area.

Source: Saxo

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