Gold is the world's original reserve currency. The precious metal serves many functions today, including (1) as a barometer of US dollar liquidity conditions, (2) as a means of assessing geopolitical risks and (3) as a hedge against high rates of inflation. The precious metal is particularly sensitive to US real interest rates, with gold prices rising when real rates fall and vice versa.
Gold prices are currently stable. Last week, gold fell below the bottom end of our trading range ($1,280). While immediate reactions in the precious metal following last week's numerous central bank events were fairly limited, gold prices crashed last Friday. Looking at bonds, US Treasury yields are falling despite an acceleration in inflation and hawkish guidance from the Federal Reserve. All else held equal, gold prices tend to strengthen as bond yields move lower. Instead of bond yields, the bigger driver behind gold is recent strength in the US dollar. Today's gold trading range is $1,276 - $1,292.
Gold prices are currently flat. Looking at bonds, US 10-year Treasury yields are also flat. Meanwhile, the US dollar index (a measure of the currency against its largest peers) is strengthening. As gold is primarily traded against the US dollar, the precious metal is negatively correlated to the buck. The negative correlation between gold prices and the US dollar is one of the strongest across all financial assets. As the US dollar remains in a bullish trend, gold prices are likely to remain weak. Our outlook on gold remains bearish.
After its most recent top around $1,309, gold is now above $1,278.
Policy: While gold sold off in November 2016 in response to rising inflation expectations (which typically elicits a monetary policy response in the form of rate hikes), gold has bounced back in 2017 and 2018. This is largely because inflation expectations fell after the first quarter of 2017, while the US dollar entered a long-term bear market. While recent tax cuts were expected to raise the outlook for inflation, ongoing weakness in the US dollar has overshadowed hopes for stronger inflation. Looking at gold in 2018, the US dollar bear market and a subdued outlook for inflation should keep gold on a strengthening path.
Sentiment: Gold has hit overbought levels according to technical indicators on a daily chart a few times in recent history. Each time, gold prices have pulled back after looking overbought. Looking at the Commitments of Traders report, speculator net positions are not yet at a bullish or bearish extreme. Accordingly, sentiment is not slowing down momentum behind the precious metal. In 2018, sentiment behind gold has been mostly bullish. If sentiment hits a bullish extreme, one should expect gold prices to experience a short-term pull back.
Economic data: With global economic growth accelerating and inflation subdued around the world, the fundamental outlook for gold is positive. Gold prices tend to strengthen when global growth is strong, as the US dollar tends to weaken under such conditions. On the other hand, low inflation ties the hands of central bankers wanting to raise interest rates, which also supports gold prices. Thus the outlook for gold, based on the current economic environment, remains positive.
In our last take on the outlook for gold, we wrote that the combination of slowing growth outside the United States and rising inflation meant more weakness lay in store for the precious metal. When both US growth and inflation are high, the Fed is more likely to raise rates with the aid of supportive data. In an environment where US growth is outperforming its major peers, the US dollar also ten…
Last week, we wrote that weakness in the US dollar is masking growing risks. As equities, commodities and corporate credit are inversely correlated to USD, investors need to pay attention to the risk of a US dollar rebound. Since early 2017, gold prices have gradually strengthened. As the precious metal serves as a barometer for US dollar liquidity, the clear message from gold was that monetar…
Since early 2017, gold has strengthened from lows below $1,080 to around $1,340 today. The underlying factors that have helped gold strengthen since that time remain intact. We argue that gold should continue strengthening in the longer-term thanks to (1) moderate sentiment, (2) continued weakness in the US dollar, and (3) a weak outlook for real interest rates. While recent price action is somew…