Quarterly Outlook
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Charu Chanana
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Headwinds for gold ahead of FOMC
Ole Hansen
Head of Commodity Strategy
Summary: Gold trades near 11-week low ahead of today’s FOMC which is expected to yield an accelerated pace of rate hikes with the market pricing in the first 50 basis-point rate hike in over twenty years. Continued dollar strength and real yields returning to positive territory being the main drivers behind the recent weakness. We look at absolute versus relative returns, and why investors are unlikely to give up on gold at this time.
Gold trades near a ten-week low ahead of today’s FOMC which is expected to yield an accelerated pace of rate hikes with the market pricing in the first 50 basis-point rate hike in over twenty years, and at least the following two meetings are expected to deliver additional half-percent rate moves. Apart from the recent correlation to lower oil, now trading higher as the EU have announced a ban on Russian oil and fuel imports, other headwinds have been created by the surging dollar, up more than 6% against a broad basket of currencies since the start of the year, and a continued rise in US bond yields. These developments have all helped send the price lower, in part driven by short-term technical selling by hedge funds and CTA’s.
From an absolute performance perspective a 1.5% year-to-date return in dollars at a time of surging inflation seems less than impressive. However when adding the tumble seen across stocks and bonds, an investor having diversified part of his portfolio to gold has little to complain about. Even less so for a non-dollar based investor who have seen a sharp divergence between gold and the mentioned asset classes.
The table below shows how a dollar-based investor has achieved a 14.2% outperformance relative to the S&P 500 and 22.2% versus an ETF tracking long duration US bonds. Across the big pond in Europe, an investor would have seen a 22.2% outperformance against the Euro Stoxx50, a pan-European stock index, and 19.3% against an ETF tracking European government bonds.
The latest weakness which gathered some momentum following Friday’s failed attempt to break above $1920/oz has been driven by a renewed rise in US ten-year real yield into positive territory for the first time since early 2020. Comparing gold and real yields at the current level around +0.12% you could argue that gold is theoretically overvalued by close to 200 dollars.
However, as we have seen in recent months, demand for gold, especially through ETF’s have remained robust during the period of rising real yields. Primarily due to re-allocations by asset managers looking for a hedge against a policy mistake, i.e., the FOMC hikes until the economy breaks, elevated volatility in stocks and bonds and a prolonged period of elevated inflation sapping the outlook for several sectors of the stock market.
In fact, the predicament of the current market situation was highlighted by Paul Tudor Jones in an interview with CNBC yesterday. He said that the environment for investors is worse than ever as the Federal Reserve is raising interest rates when financial conditions have already become increasingly tight. “Clearly you don’t want to own bonds and stocks” was one of his comments.
The sharply higher dollar against both the Indian Rupee and Chinese Renminbi, the world's biggest buyers of physical gold may trigger a challenging period for gold, until buyers adapt to higher levels, something that is likely to trigger some pent-up demand, especially in India.
Another worry is Russia and its central bank which holds a major percentage of its reserves in gold. As the unjustified and ill-conceived idea to wage war against a sovereign nation eats into its reserves, the market worry Russia would have to start sell some of their gold. Not least considering it can no longer access the euros and dollars held at private institutions and central banks in the U.S. and Europe.
At the March G7 meeting in Brussels, the group said it would continue to work jointly to blunt Russia’s ability to deploy its international reserves to prop up Russia’s economy and fund Putin’s war. They also specifically said that any transaction involving Central bank held gold would be covered by existing sanctions. That would leave India and China as the two major venues for any undercover sales of gold, a risk we see as being limited, at least at this stage.
From a technical perspective gold needs a break above $1920 in order to force buying from recent short sellers while key support below $1850 on the Comex Gold future is in a band towards $1830. Only a break below that level would begin challenging our bullish view on gold as highlighted in our quarterly outlook.
For a more detailed technical update for gold and silver from Kim Cramer, our technical analyst, please click here.
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