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Gold

The gold market screams: The Fed are done hiking

Chris Weston
Head of Research
Oct 10, 2023
It has not been the case for several months now, but the investment case for gold is certainly warming up and the reasons to own gold seemingly outweigh the reasons to be short. In a world of probabilities, the odds look to be swinging in favour of the gold bulls.

Keeping me cautious is the fact that the USD still offers appeal, and unless Europe pulls a rabbit out of a hat, the BoJ offer a clear signal of tweaks to its policy setting, or China attracts increased capital - then the USD will only grind lower and not see the sort of explosive trending price action many want as traders.

We also face a very important US CPI print on Thursday, and should we see core CPI above 4.3% (consensus 4.1%) then that could become problematic for the gold market. Conversely, a 3-handle on US core CPI and gold should find strong buying activity.  

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What does compel gold longs is that the market is becoming convinced that the Fed has finished its hiking cycle. Essentially, the powerful rise in both 10-year real and nominal Treasuries, amid the 7% rally in the trade-weighted USD, equates to a similar degree of tightening as an additional rate hike.

It’s no surprise then that an army of Fed members - Goolsbee, Daly, Bostic, Jefferson, and Logan - have in just two trading sessions, coordinated their communication in response, and effectively told market participants that the bond market has done the job for them.

While the fed funds rate may be held at current levels until at least March 2024, the next move is becoming more apparent, and the odds certainly favour it to be lower. Gold’s best days are when rates are being cut, but gold traders will not wait around until that happens – on the contrary, we live in the future and we’re pricing that risk now. 

The attack on Israel offers tailwinds for gold. Any continued rise in crude above $90 will lift headline inflation, but the gold market will be more influenced by the effect crude has as a tax on the consumer. This will only increase the probability of a recession in early Q124. Among other factors that could see slower demand, rising energy prices could be considered in the Fed easing rates to bring the Fed funds rate closer to a neutral setting.

As we typically see, it is when the US Treasury yield curve bull steepens (i.e., 2-year yields fall faster than 10-year yields) that we see the US heading towards a recession. Of course, this bet can only gain real legs when we see a 50bp or so rise in the unemployment rate, and right now the US labour market is still very tight. If we see cracks emerge in the US labour market, then gold should rally hard and cries of ‘all-time highs’ will become deafening.  

Presumably, The House of Reps will vote in a new speaker this week or next – there is certainly a significant urgency to fill the position – so much so that some have even suggested Kevin McCarthy refills the position, at least in the short-term. I suspect that is very remote indeed. Steve Scalise is considered the favourite to get the gig, and that should be neutral for risk. However, should Judiciary Chair (and uber-fiscal hawk) Jim Jordan surprise and get up then it would radically increase the prospect of a protracted govt shutdown and see gold shine as a hedge against a highly dysfunctional Congress – even if the effects are limited by workers receiving back pay.

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The technicals have turned more positive, with price defending channel support and the Feb/March low. Coming off grossly oversold levels, the upside case does need work, but a rally to $1880 looks likely, where a break would suggest a test of channel resistance at $1912.

For now, the gold market has warmed to the idea the Fed is done hiking, but to consider a move to $1981 and all-time highs, we need to increase convictions of a recession and the Fed becoming more urgent on bringing down rates to a neutral setting – that isn’t the case just yet, but it is a growing risk and enough for investors to increase the allocation of gold in portfolios as a multi-faceted hedge.

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