Sive Morten
Special Consultant to the FPA
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Fundamentals
Recent week was very important for all markets, including gold. Investors have got a cold shower from inflation data that could be treated as most important ones in recent few months. That's why yesterday we've dedicated our EUR report to inflation subject. It has brought few additional details, although has not changed major background - inflation will increase, and gold remains under pressure in nearest few months. But as closer real rates will come to zero as more support gold will start to get.
Market overview
Gold ticked up on Friday but was on course for a second straight weekly fall after hot inflation data cooled prospects of early rate cuts by the Federal Reserve. Data showed that U.S. producer prices increased more than expected in January. Another report on Tuesday showed that U.S. consumer prices rose more than expected last month. Data on Tuesday showed U.S. consumer prices in January, was at a 3.1% annual rise, above economists' forecast in a Reuters poll for a 2.9% increase.
Some safe haven demand- following data showing recessions in Japan and the UK- also aided gold prices. Poor Retails Sales, showed 0.8% drop in January also has weakened dollar. U.S. retail sales fell more than expected in January. A separate report from the Labor Department showed initial claims for state unemployment benefits fell 8,000 to a seasonally adjusted 212,000.
But despite seeing some relief, the yellow metal was still set for steep weekly losses as traders largely scaled back expectations for early rate cuts, especially following hotter-than-expected consumer price index inflation data earlier this week.
Even after Thursday’s retail sales reading, Fed officials still warned against betting on early rate cuts. Atlanta Fed President Raphael Bostic said that while the central bank had made headway towards lowering inflation, he was still not ready to call for rate cuts yet. Bostic also said that inflation will take longer to decline. His comments came just ahead of producer price index inflation data, which is due later on Friday.
Fed officials have repeatedly warned that the central bank is in no hurry to raise interest rates, given that the U.S. economy, inflation and the labor market are all still running strong. Such a scenario bodes poorly for gold prices, given that higher rates push up the opportunity cost of investing in the yellow metal. Other precious metals moved in varying directions on Friday, but were set for a much stronger weekly performance than gold, indicating that traders were potentially diversifying out of the yellow metal.
Fed policymakers will probably wait until June before cutting rates, traders bet after the inflation data. Higher interest rates increase the opportunity cost of holding bullion. Fed Vice Chair for Supervision Michael Barr on Wednesday said the path back to 2% inflation "may be a bumpy one". Meanwhile, Chicago Fed President Austan Goolsbee cautioned against delaying rate cuts for too long.
Traders have pushed back their expectations of a U.S. interest rate cut from March to June. Markets are currently pricing a 73% chance of a cut in June, according to the CME Fed Watch Tool, opens new tab. On the physical front, gold premiums in India rose to more than four-month highs this week as demand picked up, with jewellers stocking up for the wedding season.
Americans reported a fairly stable outlook for inflation at the start of the year, a New York Fed survey showed. The Federal Reserve Bank of New York said Monday in its January Survey of Consumer Expectations, opens new tab that inflation a year and five years from now were unchanged at readings of 3% and 2.5%, respectively, while the projected rise in inflation three years from now dropped to 2.4%, the lowest since March 2020, from December’s 2.6%.
In a separate report, the Cleveland Fed said business leaders also see lower inflation pressures, opens new tab. In the first-quarter survey, chief executive officers expected consumer price index inflation of 3.4% over the next year, down notably from 4.2% in the fourth-quarter survey.
Perspectives are positive, despite the pressure
Take a look at results of 2023 by World Gold Council. Despite that we see nominal decreasing of demand in 2023 - it was on high level. Only 2013 numbers were above 2022 and 2023.
Also take a look what a small impact ETF dynamic has on overall demand. According to the X-post by Bloomberg analyst Eric Balchunas, out of the 14 leading gold ETFs in 2024, the outflow of funds amounted to $2.4 billion:
Annual gold demand (excluding OTC) of 4,448t was 5% below a very strong 2022. Inclusive of significant OTC and stock flows (398t), total gold demand in 2023 was the highest on record at 4,899t. Central bank buying maintained a breakneck pace. Annual net purchases of 1,037t almost matched the 2022 record, falling just 45t short. Global gold ETFs saw a third consecutive annual outflow, losing 244t. The pace of outflows slowed markedly into year-end, but October’s hefty outflows dominated the Q4 picture.
Annual bar and coin investment saw a mild contraction (-3% y/y) as divergent trends in key Western and Eastern markets offset one another. Annual jewellery consumption held steady at 2,093t, even in the very high gold price environment. China’s recovery supported the robust global total. Despite a Q4 recovery in electronics, the annual volume of gold used in technology fell below 300t for the first time in our data series.
Gold price has not shown big drop this year, because of two reasons. First is - as we've shown above, the ETF activity is just a minor part of gold annual turnover, which is around 5.5-6.0 thousands tonnes. Second is, gold has few other more important drivers that overrule impact of ETF dynamic. Besides, Q4 gold demand of 1,150t (excluding OTC and stock flows) was 8% above the five-year average. OTC investment was reflected in gold price strength during 2023. This source of gold demand, while opaque, was clearly evident again in Q4 as the gold price rallied despite continued ETF outflows. Annual mine production increased 1% y/y to 3,644t, but fell short of the 2018 record. Full year recycling responded to high gold prices, rising to 1,237t (+9% y/y). Total gold supply was 3% higher y/y as a result.
Last year, central banks bought almost a record 1,037 tons of gold, and in 2022 - a record 1,082 tons. After record purchases by central banks in 2022 and 2023, TD Securities economists expect continued high demand from regulators.
The record pace of purchases of physical gold by central banks and the renewed interest of investors in protecting against declining purchasing power, default risks as U.S. debt rises to dangerously high levels and sanctions risks associated with geopolitical tensions in the Middle East and Eastern Europe may be factors that will not only provide support for prices, as it is it was last year, but it will also strengthen any rally caused by speculation.
It is interesting that in recent Goldman Sachs report, they forecast relatively stable long-term interest rates. They absolutely do not expect rates raise above 4.0%. Since we expect strong jump in inflation this year, real rates could turn deeply negative that could change sentiment on gold market.
Besides, GS shows very conservative forecast on coming bond issues. If you take a careful look at below charts you could see that GS doesn't expect raising of borrowings from the US Treasury, keeping bond issue around 300 Bln per month and suggests that its share will not raise. Although on the low left chart you could see that free float (off the Fed holdings) is constantly raising. With raising budget deficit and detailed look at the US economy data it is difficult to agree that bonds' supply will remain flat through 2024-2026. This gives us more confidence with our suggestion of decreasing of real interest rates, as supply of the bonds will raise. Actually on right top chart we already could see that 2023-2024 supply already replaced the Fed that stopped QE in Q2 2022.
For now global bonds have lost all gains after sudden changing in inflationary environment. Two months ago when euphoria has started - we warned that this is temporal relief. The Bloomberg global debt index has fallen 3.5% this year, wiping out all gains made since December 12, the day before the Fed's statement later that month.
The strength of the US economy is making Treasuries unattractive at the moment, even though rate expectations are now better aligned with the Fed's own forecasts, according to Amy Xie Patrick, head of bond market strategy at Pendal Group in Sydney. It has withdrawn from participating in US government bonds and is currently focusing more on corporate bonds.
Adding few moments on inflation statistics and its possible "adjustment". Recently CNBC has made its own investigation and indirectly hints that official numbers might be intentionally lowed. They have noted some components of large categories that show significantly higher rates of price growth. Although they don't write about it evidently, there is a feeling that they want to emphasize that everything is not OK with the final inflation of 3.1%. It is separately noted that housing has grown by 6% over the year, and housing weighs almost a third of the total CPI. Just take a look at this:
Still, nearest few months could be tough...
The only problem with inspiring perspectives for gold is to wait when it comes. Until this moment raising inflation and hawkish Fed rhetoric will keep gold under pressure, do not let real rates to fall. The Fed together with US Treasury will use existed reserves of Repo market (~600 Bln) and Treasury cash (~800 Bln) to support stock market and coup any problems in banking sector. Additional pressure will be from US Dollar performance.
Currency markets still appear to be in thrall to the so-called "dollar smile" - the model that posits two extreme scenarios which both tend to boost the dollar. The theory is essentially this: the dollar rises in good times (relatively strong U.S. growth, "risk-on" markets and high asset returns) and in bad (times of global risk aversion that draw domestic capital home to cash and overseas money to the safety of U.S. Treasuries), but sags in between. Those "in between" times are often when U.S. interest rates are low or falling, and the domestic economy is muddling along or under-performing relative to its global peers.
Right now, the dollar is being underpinned to varying degrees by both sides of that smile: market turmoil in China, recession in Japan and Britain, and geopolitical tensions around the globe on one; a stubborn Federal Reserve that is in no rush to ease policy ahead of other central banks, and a booming tech-led Wall Street on the other. Also we need to add here commercial real estate problems and small&mid size banking crisis.
Two factors could push the dollar higher still in the near term - investor positioning and rate differentials. While many of the big investment banks, such as JP Morgan, HSBC and Deutsche Bank, are recommending their clients buy dollars over other currencies, the speculative trading community has yet to fully get on board. The latest Commodity Futures Trading Commission figures show that hedge funds are still net short of dollars. But, funds have cut their net long euro position to the smallest since October of 2022, but they are still effectively holding an $8.4 billion bet that the single currency will strengthen. This positions supposedly will be unwound soon. That's a bold call when relative U.S. and euro zone rate expectations are shifting further in the dollar's favor
Whether traders think the Fed's rate-cutting cycle will be shallower than expected or because inflation is uncomfortably hot, the result is the same - a stronger dollar.
Deutsche Bank's Alan Ruskin reckons the dollar's sensitivity to the Fed's first move is such that if the U.S. central bank doesn't cut rates in May, the euro will fall towards $1.05. His counterparts at JP Morgan agree, and even float the possibility that the euro tests 1-to-1 parity with the dollar in the coming months if the euro zone's economic downturn deepens (And it deepens).
Conclusion:
Now it is unique situation. Markets are vitally undervalue probability of hawkish steps from the Fed - either conservative (to keep rates high for longer) or aggressive to raise rate more. Investors are too inspired with NFP and GDP dynamic, stock market performance, still believing that rate will be cut in June. Even IMF thinks the same. Recent inflation and Retail Sales data has not changed this situation, making almost no impact on expectations. This leads to strong undervaluation of the US yields performance and dollar strength in nearest future.
Second misprising is inflation. Nobody expects strong inflation spiral in nearest 12 months. We suggest that it might be even in excess of the first wave of 2022. Combination of these to major driving factors lets us to create the strategy for the gold. Since the Fed is limited with its ability to raise rates that we could see from GS forecast above, the conservative scenario suggests retracement to ~1930$ area on gold within nearest 3-5 months. Negative scenario suggests drop to ~1860$ area in a case if inflation jump comes earlier, prior the exhausting of the Fed cash limits to control situation. This could be accompanied with existed upward trend as on stock market as jump in US Treasury bonds.
If everything goes with our central view, that major inflation hit will happen closer to the end of 2024 this should lead to fast risk aversion, drop of the stock market and collapse on real interest rates that should support gold. The point is, any big jump in inflation will push nominal interest rates higher, but rates are usually lag behind the inflation pace that we saw in 2021-2022 and second - high rates very soon will make negative impact as on stocks as on economy sentiment that will lead to drop of real interest rates.
Whatever scenario will be, we consider potential pullback as a good chance for accumulation long-term bullish positions of investment kind and physical gold. In our shorter-term day by day trading we will follow to bearish signals as well, as we usually do.
Recent week was very important for all markets, including gold. Investors have got a cold shower from inflation data that could be treated as most important ones in recent few months. That's why yesterday we've dedicated our EUR report to inflation subject. It has brought few additional details, although has not changed major background - inflation will increase, and gold remains under pressure in nearest few months. But as closer real rates will come to zero as more support gold will start to get.
Market overview
Gold ticked up on Friday but was on course for a second straight weekly fall after hot inflation data cooled prospects of early rate cuts by the Federal Reserve. Data showed that U.S. producer prices increased more than expected in January. Another report on Tuesday showed that U.S. consumer prices rose more than expected last month. Data on Tuesday showed U.S. consumer prices in January, was at a 3.1% annual rise, above economists' forecast in a Reuters poll for a 2.9% increase.
Some safe haven demand- following data showing recessions in Japan and the UK- also aided gold prices. Poor Retails Sales, showed 0.8% drop in January also has weakened dollar. U.S. retail sales fell more than expected in January. A separate report from the Labor Department showed initial claims for state unemployment benefits fell 8,000 to a seasonally adjusted 212,000.
But despite seeing some relief, the yellow metal was still set for steep weekly losses as traders largely scaled back expectations for early rate cuts, especially following hotter-than-expected consumer price index inflation data earlier this week.
Even after Thursday’s retail sales reading, Fed officials still warned against betting on early rate cuts. Atlanta Fed President Raphael Bostic said that while the central bank had made headway towards lowering inflation, he was still not ready to call for rate cuts yet. Bostic also said that inflation will take longer to decline. His comments came just ahead of producer price index inflation data, which is due later on Friday.
Fed officials have repeatedly warned that the central bank is in no hurry to raise interest rates, given that the U.S. economy, inflation and the labor market are all still running strong. Such a scenario bodes poorly for gold prices, given that higher rates push up the opportunity cost of investing in the yellow metal. Other precious metals moved in varying directions on Friday, but were set for a much stronger weekly performance than gold, indicating that traders were potentially diversifying out of the yellow metal.
Fed policymakers will probably wait until June before cutting rates, traders bet after the inflation data. Higher interest rates increase the opportunity cost of holding bullion. Fed Vice Chair for Supervision Michael Barr on Wednesday said the path back to 2% inflation "may be a bumpy one". Meanwhile, Chicago Fed President Austan Goolsbee cautioned against delaying rate cuts for too long.
Traders have pushed back their expectations of a U.S. interest rate cut from March to June. Markets are currently pricing a 73% chance of a cut in June, according to the CME Fed Watch Tool, opens new tab. On the physical front, gold premiums in India rose to more than four-month highs this week as demand picked up, with jewellers stocking up for the wedding season.
Americans reported a fairly stable outlook for inflation at the start of the year, a New York Fed survey showed. The Federal Reserve Bank of New York said Monday in its January Survey of Consumer Expectations, opens new tab that inflation a year and five years from now were unchanged at readings of 3% and 2.5%, respectively, while the projected rise in inflation three years from now dropped to 2.4%, the lowest since March 2020, from December’s 2.6%.
In a separate report, the Cleveland Fed said business leaders also see lower inflation pressures, opens new tab. In the first-quarter survey, chief executive officers expected consumer price index inflation of 3.4% over the next year, down notably from 4.2% in the fourth-quarter survey.
Perspectives are positive, despite the pressure
Take a look at results of 2023 by World Gold Council. Despite that we see nominal decreasing of demand in 2023 - it was on high level. Only 2013 numbers were above 2022 and 2023.
Also take a look what a small impact ETF dynamic has on overall demand. According to the X-post by Bloomberg analyst Eric Balchunas, out of the 14 leading gold ETFs in 2024, the outflow of funds amounted to $2.4 billion:
Annual gold demand (excluding OTC) of 4,448t was 5% below a very strong 2022. Inclusive of significant OTC and stock flows (398t), total gold demand in 2023 was the highest on record at 4,899t. Central bank buying maintained a breakneck pace. Annual net purchases of 1,037t almost matched the 2022 record, falling just 45t short. Global gold ETFs saw a third consecutive annual outflow, losing 244t. The pace of outflows slowed markedly into year-end, but October’s hefty outflows dominated the Q4 picture.
Annual bar and coin investment saw a mild contraction (-3% y/y) as divergent trends in key Western and Eastern markets offset one another. Annual jewellery consumption held steady at 2,093t, even in the very high gold price environment. China’s recovery supported the robust global total. Despite a Q4 recovery in electronics, the annual volume of gold used in technology fell below 300t for the first time in our data series.
Gold price has not shown big drop this year, because of two reasons. First is - as we've shown above, the ETF activity is just a minor part of gold annual turnover, which is around 5.5-6.0 thousands tonnes. Second is, gold has few other more important drivers that overrule impact of ETF dynamic. Besides, Q4 gold demand of 1,150t (excluding OTC and stock flows) was 8% above the five-year average. OTC investment was reflected in gold price strength during 2023. This source of gold demand, while opaque, was clearly evident again in Q4 as the gold price rallied despite continued ETF outflows. Annual mine production increased 1% y/y to 3,644t, but fell short of the 2018 record. Full year recycling responded to high gold prices, rising to 1,237t (+9% y/y). Total gold supply was 3% higher y/y as a result.
Last year, central banks bought almost a record 1,037 tons of gold, and in 2022 - a record 1,082 tons. After record purchases by central banks in 2022 and 2023, TD Securities economists expect continued high demand from regulators.
The record pace of purchases of physical gold by central banks and the renewed interest of investors in protecting against declining purchasing power, default risks as U.S. debt rises to dangerously high levels and sanctions risks associated with geopolitical tensions in the Middle East and Eastern Europe may be factors that will not only provide support for prices, as it is it was last year, but it will also strengthen any rally caused by speculation.
It is interesting that in recent Goldman Sachs report, they forecast relatively stable long-term interest rates. They absolutely do not expect rates raise above 4.0%. Since we expect strong jump in inflation this year, real rates could turn deeply negative that could change sentiment on gold market.
Besides, GS shows very conservative forecast on coming bond issues. If you take a careful look at below charts you could see that GS doesn't expect raising of borrowings from the US Treasury, keeping bond issue around 300 Bln per month and suggests that its share will not raise. Although on the low left chart you could see that free float (off the Fed holdings) is constantly raising. With raising budget deficit and detailed look at the US economy data it is difficult to agree that bonds' supply will remain flat through 2024-2026. This gives us more confidence with our suggestion of decreasing of real interest rates, as supply of the bonds will raise. Actually on right top chart we already could see that 2023-2024 supply already replaced the Fed that stopped QE in Q2 2022.
For now global bonds have lost all gains after sudden changing in inflationary environment. Two months ago when euphoria has started - we warned that this is temporal relief. The Bloomberg global debt index has fallen 3.5% this year, wiping out all gains made since December 12, the day before the Fed's statement later that month.
The strength of the US economy is making Treasuries unattractive at the moment, even though rate expectations are now better aligned with the Fed's own forecasts, according to Amy Xie Patrick, head of bond market strategy at Pendal Group in Sydney. It has withdrawn from participating in US government bonds and is currently focusing more on corporate bonds.
Adding few moments on inflation statistics and its possible "adjustment". Recently CNBC has made its own investigation and indirectly hints that official numbers might be intentionally lowed. They have noted some components of large categories that show significantly higher rates of price growth. Although they don't write about it evidently, there is a feeling that they want to emphasize that everything is not OK with the final inflation of 3.1%. It is separately noted that housing has grown by 6% over the year, and housing weighs almost a third of the total CPI. Just take a look at this:
Still, nearest few months could be tough...
The only problem with inspiring perspectives for gold is to wait when it comes. Until this moment raising inflation and hawkish Fed rhetoric will keep gold under pressure, do not let real rates to fall. The Fed together with US Treasury will use existed reserves of Repo market (~600 Bln) and Treasury cash (~800 Bln) to support stock market and coup any problems in banking sector. Additional pressure will be from US Dollar performance.
Currency markets still appear to be in thrall to the so-called "dollar smile" - the model that posits two extreme scenarios which both tend to boost the dollar. The theory is essentially this: the dollar rises in good times (relatively strong U.S. growth, "risk-on" markets and high asset returns) and in bad (times of global risk aversion that draw domestic capital home to cash and overseas money to the safety of U.S. Treasuries), but sags in between. Those "in between" times are often when U.S. interest rates are low or falling, and the domestic economy is muddling along or under-performing relative to its global peers.
Right now, the dollar is being underpinned to varying degrees by both sides of that smile: market turmoil in China, recession in Japan and Britain, and geopolitical tensions around the globe on one; a stubborn Federal Reserve that is in no rush to ease policy ahead of other central banks, and a booming tech-led Wall Street on the other. Also we need to add here commercial real estate problems and small&mid size banking crisis.
Two factors could push the dollar higher still in the near term - investor positioning and rate differentials. While many of the big investment banks, such as JP Morgan, HSBC and Deutsche Bank, are recommending their clients buy dollars over other currencies, the speculative trading community has yet to fully get on board. The latest Commodity Futures Trading Commission figures show that hedge funds are still net short of dollars. But, funds have cut their net long euro position to the smallest since October of 2022, but they are still effectively holding an $8.4 billion bet that the single currency will strengthen. This positions supposedly will be unwound soon. That's a bold call when relative U.S. and euro zone rate expectations are shifting further in the dollar's favor
Whether traders think the Fed's rate-cutting cycle will be shallower than expected or because inflation is uncomfortably hot, the result is the same - a stronger dollar.
Deutsche Bank's Alan Ruskin reckons the dollar's sensitivity to the Fed's first move is such that if the U.S. central bank doesn't cut rates in May, the euro will fall towards $1.05. His counterparts at JP Morgan agree, and even float the possibility that the euro tests 1-to-1 parity with the dollar in the coming months if the euro zone's economic downturn deepens (And it deepens).
Conclusion:
Now it is unique situation. Markets are vitally undervalue probability of hawkish steps from the Fed - either conservative (to keep rates high for longer) or aggressive to raise rate more. Investors are too inspired with NFP and GDP dynamic, stock market performance, still believing that rate will be cut in June. Even IMF thinks the same. Recent inflation and Retail Sales data has not changed this situation, making almost no impact on expectations. This leads to strong undervaluation of the US yields performance and dollar strength in nearest future.
Second misprising is inflation. Nobody expects strong inflation spiral in nearest 12 months. We suggest that it might be even in excess of the first wave of 2022. Combination of these to major driving factors lets us to create the strategy for the gold. Since the Fed is limited with its ability to raise rates that we could see from GS forecast above, the conservative scenario suggests retracement to ~1930$ area on gold within nearest 3-5 months. Negative scenario suggests drop to ~1860$ area in a case if inflation jump comes earlier, prior the exhausting of the Fed cash limits to control situation. This could be accompanied with existed upward trend as on stock market as jump in US Treasury bonds.
If everything goes with our central view, that major inflation hit will happen closer to the end of 2024 this should lead to fast risk aversion, drop of the stock market and collapse on real interest rates that should support gold. The point is, any big jump in inflation will push nominal interest rates higher, but rates are usually lag behind the inflation pace that we saw in 2021-2022 and second - high rates very soon will make negative impact as on stocks as on economy sentiment that will lead to drop of real interest rates.
Whatever scenario will be, we consider potential pullback as a good chance for accumulation long-term bullish positions of investment kind and physical gold. In our shorter-term day by day trading we will follow to bearish signals as well, as we usually do.
