Gold has been one of the best performers of major assets in the past three months. A multi-month rally has taken hold of gold since November. The move has coincided with two crucial factors, the topping out of US Treasury yields and the correction of the USD.
The gold price has consistently strong negative correlations with both US bond yields and the USD. As yields and the USD have moved lower, this has allowed gold to rally.
However, gold price has retreated recently. This has brought the price back to important support. What caused the rally in gold prices, and why has it now started to fall?
US treasury yields have topped out, helping to support gold
The reason is that firstly, gold is a zero-yielding asset. Rising bond yields increase the opportunity cost of owning gold (higher-yielding assets have a better return).
Subsequently, when yields fall, gold starts to perform much better.
We see here on the chart of gold versus the US 10-year real yield (this is taken as the US 10-year Treasury Inflation-Protected Securities).
The average correlation is -0.43 over 12 months. Notably, since real yields peaked in November, gold has been rallying.
The other factor is the correction in the USD - gold and the USD remain negatively correlated
Once more, gold and the USD have a strong negative correlation. It averages around -0.52 over the past 12 months. This would suggest that the USD is the decisive driver of gold.
The chart shows that the performance of the USD and gold has been a near-perfect mirror image, aside from the immediate reaction to the breakout of the Ukraine war (when gold and the USD both rallied as safe havens).
Gold has fallen in early February as the USD rebounded. Will this continue?
Gold has fallen in February as the USD has rebounded. This has come amid an adjustment in expectations over Federal Reserve monetary policy.
The strong Nonfarm Payrolls data has shifted expectations of when the Fed might hit the terminal level of the Fed Funds rate. Suddenly a May hike is becoming increasingly probable.
The Fed Funds rate is currently at 4.75% and a 25bps rate hike is nailed on for March.
But there could now be another 25bps hike in May too (although, there is a high likelihood that 5.25% would be the terminal rate).
Fed Funds futures have the terminal rate now around 5.15%. According to the CME Group FedWatch Tool, it suggests that the probability of a rate hike in May hike is currently around 75%.
This has room to increase further.
If it does, bond yields will move higher and it would be USD positive. Both of these factors would pull gold lower and the near-term correction would continue.
Fed Chair Powell has said recently that the Fed will become more data-dependent in the meetings to come. However, Fed speakers have also been leaning more hawkish. The FOMC’s Thomas Barkin said that it was important to continue hiking to rein in inflation.
This suggests that both inflation and labour market data will therefore be important.
We will be watching the US CPI inflation data in the coming week, but the next Nonfarm Payrolls on 10th February is also a crucial data point.
What is needed to see gold rally again in the coming weeks?
Gold has been an excellent performer of the major assets over the past three months. The chart below shows that only the incredible jump in Bitcoin throughout January means that it is not the standout performer.
For this performance to continue, there are some charts we will be keeping an eye on.
US 10-year and 2-year Treasury yields.
The downtrend on the US 10-year Treasury yield since late October is notable. It is being tested as yields have moved higher this week. If the downtrend breaks and the yield moves above the 3.90% January high it would be negative for gold.
We are also watching the band between 4.52% and 4.57% on the 2-year yield. Moving above here would be a three-month high and also suggest a shift in the market outlook on interest rates.
The resistance band between 103.40/104.65 is key. If this continues to hold back any rallies, then this should also help to support gold.
On the data front:
The continued decline in both headline and core CPI inflation would be gold supportive
Also, watch for inflation trends falling in other metrics such as the Michigan Sentiment (consumer inflation expectations) and the core PCE.
Signs of cooling in the labour market indicators (such as the jobless claims rising, JOLTS jobs openings falling, ISM Employment components) and of course Nonfarm Payrolls falling would also help.
Technicals are beginning to look less positive
On the technicals, the early February correction is testing the support band between $1850/$1880. This means that the medium-term bullish outlook is being tested.
A three-month uptrend has been broken in recent days.
The daily RSI is at three-month lows and is holding below 50 – this is a growing corrective configuration.
For now, the price remains above the rising 55-day moving average (historically a good gauge for the outlook).
The resistance at $1890/$1896 is now key near to medium term. This needs to be broken for the bulls to get back in control.
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