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.
As the US dollar trades at 3-year lows, gold continues to shine. The precious metal has enjoyed a great week, and has strengthened by more than $50 in the last five trading days. Gold enjoyed the biggest gains when both inflation expectations were rising alongside weakness in the US dollar. Looking forward, we expect the US dollar to keep weakening, but are more doubtful on inflation expectations. Inflation looks set to be weighted down by falling commodity prices and base effects. As inflation was fairly high at this time last year, year-over-year inflation rates are likely to struggle going forward. While the gold bull market looks set to continue, the pace of gains are likely to be more measured going forward. Our short-term outlook on gold remains neutral, while our medium-term outlook remains bullish.
After its most recent bottom around $1,315, gold is now above $1,358.
As gold strengthens, we are upgrading gold to bullish in the short-term. Note that gold is now trading within a normal range. This is based on various technical indicators on the daily chart.
Following recent strength in gold, we are upgrading the precious metal to bullish in the medium-term. The precious metal is trading within normal conditions. This is based on technical indicators on a weekly chart.
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.
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