US dollar dictates gold’s short-term direction
Gold slumped below $1820 this week and, following a more than $340 rally since early November, the market has now given back close to $140. The trigger which saw the price trade lower after being rejected at $1950 was a recent batch of stronger than expected US economic data—highlighting the challenge the US Federal Reserve is facing as it attempts to force inflation lower towards its long-term target of 2%. This has led to renewed strength following several months of dollar weakness, while bond yields have moved higher. Both developments, given their inverse correlation, have provided gold with fresh headwinds.
For now, gold is likely to take much of its directional inspiration from the dollar and, until we see another rollover, gold will continue to look for support. Demand for gold remains uneven, but in the short term we anticipate that central bank demand will more than offset a continued lack of appetite from investors in the ETF market where total holdings continue to be reduced, down by almost 50 tons since early November when gold began its strong run up in prices.
Until macro-economic developments turn more friendly, and the dollar rolls over yet again, the risk remains of a further weakness towards $1788 followed by the 200DMA at $1,776. US PCE deflator, the Fed’s preferred inflation gauge, was closely watched on Friday with the stronger than expected result clearly indicating that inflation is heading in the wrong direction, and that further action is needed from the FOMC, potentially putting a 50 basis point hike back in play. The core PCE inflation rose 0.6% on the month with the year-on-year rise accelerating to 4.7%.
Backwardation points to continued strength in commodities
The tightness seen across the commodity sector which helped drive strong performance during the last few years has eased in recent months while China struggled with lockdowns, but despite concerns of an economic downturn, the bulk of the major commodities tracked in the Bloomberg Commodity Index – those with an index weight above 2.5% – continue to trade in backwardation. The one-year average weighted implied roll yield, however, is currently trading at a small contango as the whole index is being pulled down by a massive 55% one-year contango in natural gas. Given our expectations for a strong rebound in China and a shallow economic slowdown elsewhere, we expect an investor-friendly backwardation will start to rise from the second quarter and onwards, primarily driven by the energy sector.