Head of Commodity Strategy
Summary: Gold, silver and copper's performances following last week’s FOMC meeting, when Fed Chair Powell delivered a hammer-blow to sentiment across markets, have been very impressive. All three metals have recovered strongly and are now getting close to levels that may trigger a change in the established "sell-into-strength" mentality. In this we take a closer look at gold and what is required for the mentioned change to occur.
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Gold, silver and copper’s performances following last week’s FOMC meeting, when Fed Chair Powell delivered a hammer-blow to sentiment across markets, have been very impressive. Gold trades up almost 100 dollars from the post-FOMC low at $1615, now a potential triple bottom, while silver has returned to challenging the 200-day moving average at $21.50 for the first time since the April slump. In addition, supply disruptions from miners in South America, tight supply and speculation about a change in China’s approach to its handling of Covid breakouts have supported copper’s move to near the top of its current range, thereby supporting silver's outperformance against gold which has seen the gold-silver ratio drop to the lowest since April at 80 ounces of silver to one ounce of gold.
Above all, the dollar remains a key source of directional inspiration to most commodities, not least precious and industrial metals, and despite Fed Chair Powell’s attempt to present a hawkish and dollar-supportive outlook last week, the greenback continues to show signs of rolling over, not least against the euro which has moved back above parity. Futures speculators have been net buyers of the euro since late August, and in the week to November 1, the day before the FOMC meeting, buying accelerated with the net long rising to a 19-month high.
Gold normally derives most of its directional inspiration from the movements in the dollar and Treasury yields, and it helps explain the relatively poor performance this year when the metal was up against the biggest dollar and yield jump in decades. Recently, however, the focus has increasingly switched to the dollar as highlighted by the strong correlation between the broad-based Bloomberg Dollar Index and gold in the chart above.
Supporting the underlying improvement in sentiment was the Gold Demand Trends Q3 2022 update from the World Gold Council in which they saw central bank demand reaching a quarterly record of nearly 400 tons, thereby offsetting a 227 tons outflow from bullion-backed ETFs. Overall, the year-to-date demand increased 18% versus the same period in 2021, returning to pre-pandemic levels.
With underlying physical demand, especially from emerging markets’ central banks, heading for a record year, the market still needs demand from investors in ETFs and speculators in futures to pick up, and for that to happen the dollar and yields still need to send a clear signal they are rolling over. High inflation tends to be gold negative as long as investors maintain a trust in central banks’ ability to bring it under control as it lifts real yields while keeping breakeven (inflation) levels subdued. The situation tends to reverse if the market starts questioning that ability, especially if a growth shock pushes the US economy into a recession before the Fed successfully manages to bring inflation under control.
At Saxo, we maintain a long-held view that the medium-term inflation outlook will likely surprise to the upside with a 4% to 5% range over the next decade not being that outrageous. Driven by a new geopolitical situation where the world is splitting into two parts with everything evolving around deglobalization driven by the need for self-reliance. Together with the energy transition, we are facing a decade that will be commodity and capital intensive, and where scarcity of raw materials and labor will keep inflation elevated for longer and higher than the 3% level currently being priced in through the swaps market.
Such a scenario combined with the risk of an economic slowdown forcing a roll over in central bank rate hike expectations, sending real yields and the dollar lower, may in our opinion create powerful tailwinds for gold and silver during 2023.
The market will turn its attention to Thursdays US October CPI print for additional guidance with forecasts pointing to easing price pressures. If realised it may support bullion through a weaker dollar as the FOMC would be more inclined to slow its pace of rate hikes. On the other hand a stronger than expected number may trigger a kneejerk downside reaction before recovering as investors and traders begin to wonder, as mentioned above, whether the FOMC will be successful in bringing inflation under control in time to avoid a major economic downturn.
With support firmly established at $1615, and following yesterday’s break above the $1675-80 resistance-turned-support area, the market will now be focusing on the key $1735 level, a break above which may signal a low in the market and the beginning of a recovery.
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Markets are driven by election optimism, overshadowing growing debt and liquidity concerns. The 2024 elections loom large, but economic fundamentals and debt issues warrant cautious investment.
As US economic slowdown hints at a shift away from exceptionalism, USD faces downside with looming Fed cuts. AUD and NZD set to outperform as their rate cuts lag. JPY gains on carry unwind bets and BOJ pivot.
Amid AI and obesity drug excitement, equities see varied prospects: neutral on overvalued US stocks, negative on Japan due to JPY risks, positive on Europe. European defence stocks gain appeal.
With the economic slowdown, quality assets will gain favour, especially sovereign bonds up to 5 years. Central banks' potential rate cuts in Q2 suggest extending duration, despite policy and inflation concerns.
Commodities poised for rebound. The "Year of the Metal" boosts gold and silver, copper awaits rate cuts. Grains may recover, natural gas stabilises. Gold targets $2,300-$2,500/oz, copper's breakout could signal growth.
