Gold Plunges Back Towards Multi-Month Lows

Without a lowering of inflation, the precious metal is unlikely to notch any lasting gains.

Gold prices are once again on the retreat as the US dollar rebounds from a brief pullback after significant momentum higher over the last two weeks.  Optimism that the economy will benefit from US President-elect Donald Trump’s sweeping proposals has been enough to fire up a rally in risk assets across the board, hurting haven assets such as gold, which are normally used to hedge against uncertainty.

Despite the fact that the next US government could run afoul of its objectives, gold prices reflect the overwhelmingly positive sentiment accompanying the proposed measures.

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Should the case for further rate hikes continue to build after the December FOMC decision, gold prices could easily find themselves trending back near multi-year lows and retesting the critical $1050 support level.  However, this development would be solely dependent on the Federal Reserve cuing up financial markets for further normalization efforts and a gradual pace of tightening.

Nevertheless, there are numerous challenges that could thwart such a strategy, preventing any deeper slide back below $1000 per troy ounce.

Risk Asset Momentum Sees Haven Asset Outflows Accelerate

Between the gains in the US dollar and equities, investors have been rapidly rotating exposure in their portfolios to account for the more upbeat outlook for policy and the economy.  Although the prospect of higher interest rates has led to widespread losses in bond markets as investors wait for better yields to emerge, the real move has been in FX and equity benchmarks.

The positive tailwinds for the US dollar from elevated probability of higher interest rates and more focused fiscal stimulus have driven the currency to 13-year highs against a basket of currencies from other advanced economies.

Considering the historically strong inverse relationship with gold, any further gains in the US dollar will likely be a force that pressures gold prices lower.  Besides its relationship to fiat currencies, gold is likely to be rotated out of portfolios because it is a non-yielding asset.  This means that the instrument pays no dividends or is not a productive asset that creates goods and services.

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Gold’s use as a store of value is quickly losing favor.  Furthermore, the sensitivity to interest rates implies that any future rate hikes will be a negative development for precious metals.  As the case strengthens for not just one rate, but multiple, the selloff will likely be extended.

Outlook Dependent

One of the main factors that will create the conditions necessary for a lasting drop in gold prices is the establishment of a firmer timeline for future rate hikes.  At present, financial markets only appear to be pricing in the probability of one rate hike during 2017.  Should inflation remain stable at current levels, two rate hikes might be possible before the end of the calendar year.

If inflation should experience a pickup thanks to rising fiscal spending and tax reform which spurs greater velocity of money through the economy, anywhere between 3 and 4 rate hikes may be possible.  However, this third scenario is the most optimistic out of the three, meaning that it is the least likely.

The adverse scenario implies that December marks the last rate increase for an extended period of time.  The reasons for such a case are multitudinous, including the possibility that the US business cycle is about to turn over after near 7-year bull market.

Considering leverage of US corporations and households has reached the highest levels since before the crisis, a recession could unfold that is largely beyond the scope of the White House or Central Bank to fix.  In such a case, the reasons for holding gold may be boosted significantly.

However, any momentum higher in precious metals will be largely dependent on inflation creeping lower while the economic outlook becomes less clear, hurting dollar momentum.  Without this supportive backdrop for gold, the precious metal is unlikely to notch any lasting gains.

Looking Ahead

The steep selloff in gold prices on Wednesday ahead of the NYMEX Thanksgiving close likely reflects the growing shift back to yield instead of safety.  Over 50,000 gold futures contracts were sold after data relating to US durable goods was released.  The more optimistic durable goods orders report has once again sparked favorable sentiment towards the US outlook, thus reducing the value of holding gold.

After crashing below $1200, gold prices are likely to remain under pressure towards support at $1132 as the downward momentum accelerates amid reduced risk aversion and the focus on rotation to higher yielding assets.

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