Sive Morten
Special Consultant to the FPA
- Messages
- 18,648
Fundamentals
Recent plunge on the gold market looks frustrating for many traders who have counted on unstoppable rally. But with some easing in geopolitical tensions and when military events become routine, despite how cynic it might sounds, the emotional component of the recent rally exhausted. In fact, we should not be surprised with it, as it happens everytime, when some exceptional events are over, but it doesn't mean that we should place the gravestone upon the Gold market. Because of eliminating of emotional component, price drops, but it drops not at the same level as it was a month ago. The financial component of the gold rally is still on the market and sooner rather than later but it finds the way into the price level. Market just needs to find the ground, give investors time to absorb the new reality and shake out some extreme volatility. When the dust settles a bit, market starts reflecting the ongoing processes in the US and global economy.
Market overview
As was widely expected, the U.S. Federal Reserve raised the fed funds rate by 25 basis points (bps) at its March meeting and strongly signaled more hikes to come given a tight labor market and surging inflation. The Fed also released a new Summary of Economic Projections, which shows large upward revisions to the inflation outlook and a significant corresponding pull-forward of more rate hikes into 2022 and 2023.
The outbreak of war in Europe has made a difficult balancing act even more challenging for Fed policymakers as they weigh an uncertain growth outlook against another jump in inflation. However, the Fed signaled that it thinks inflation risks materially outweigh the downside risks to growth, and as a result we expect the Fed to continue its path toward higher rates and a smaller balance sheet. The Fed would likely need to see significant economic slowing and market dysfunction before shifting from its hiking path, as higher and more broad-based price increases further raise the risk that inflation expectations become unanchored. While elevated inflation risks justify a tighter stance of monetary policy, a faster pace of rate hikes will likely weigh on growth over time as financial conditions tighten more abruptly.
Along with the expected policy rate hike, the Fed conveyed an overall hawkish tone in the March FOMC statement and economic projections, as well as in Chair Jerome Powell’s press conference, by making several key changes. First, the Fed added forward guidance to the statement, noting that “ongoing further increases” of the Fed funds rate as well as a reduction in the balance sheet were likely. Second, the Fed had major revisions to the March economic projections relative to the previous forecasts in December 2021. U.S. inflation noticeably outpaced consensus expectations, particularly in January, which combined with additional inflationary impulse from war in Europe, prompted Fed officials to upgrade their inflation forecasts for 2022 by more than 1 percentage point. Officials also penciled in more modest declines in inflation in 2023 and 2024, keeping inflation meaningfully above the Fed’s 2% target over the forecast horizon. (The Fed’s preferred inflation measure is PCE – personal consumption expenditures.)
Consistent with inflation no longer being expected to come back down to target in the forecast horizon and Fed officials seeing inflation pressures as broader based, officials sharply revised their interest rate forecasts higher, and most now expect policy to be above neutral by the end of next year. The median forecast is now for a 1.875% fed funds rate at the end of 2022 (versus 0.875% forecast in December) and 2.750% at the end of 2023 (versus 1.625% previously). Of note, the dot plot shows most officials are forecasting rates somewhat above their median estimate of neutral of 2.4%, suggesting that Fed officials think policy needs to be at least somewhat contractionary to bring inflation back to target.
At the press conference, Chair Powell offered background on these hawkish forecasts while he also sought to preserve optionality to change the policy path as needed in the weeks and months ahead. Similar to his comments earlier this year, Chair Powell did not take the possibility of larger rate increases off the table.
After the Fed concluded its asset purchase program earlier in the month, Chair Powell confirmed our expectations that an earlier and faster start to balance sheet runoff relative to the past cycle will likely be announced at one of the next two meetings. A smaller balance sheet would also contribute to monetary policy tightening this year, and Chair Powell suggested that many officials saw balance sheet runoff as equivalent to an additional rate hike.
By Pimco opinion, looking beyond the March meeting, we expect higher inflation and concerns about inflation expectations to continue to weigh more heavily on Fed officials than downside risks to growth in the coming months. As a result, our baseline forecast remains that there will be rate hikes at consecutive Fed meetings and a meaningful further tightening of policy throughout the year. This faster pace of tightening raises the risk of a hard landing further down the road and suggests a higher risk of a recession over the next 2 years.
Even with the tougher rate increases now projected, the Fed expects inflation to remain at 4.3% this year, dropping to 2.7% in 2023 and to 2.3% in 2024. The unemployment rate is seen dropping to 3.5% this year and remaining at that level next year, but is projected to rise slightly to 3.6% in 2024.
St. Louis Fed President James Bullard, who dissented on this week's action in favor of a half-point increase, said on Friday that officials should raise the Fed's overnight lending rate to more than 3% this year.
The Fed did project the equivalent of quarter-percentage-point rate increases at each of its six remaining policy meetings this year but that was in line with market expectations for rates. After the Fed announced its rate hike decision, benchmark 10-year U.S. Treasury yields reached 2.246%, the highest since May 2019, before retreating to 2.192%. Two-year note yields rose to 2.002%, further flattening the closely-watched yield curve.
One generally accepted, forward-looking indicator for a recession has been the 10-two Treasury yield spread. When this figure becomes inverted, market participants are no longer incentivized to invest in longer-dated securities since short-term issues provide the same yield and similar risk. The 10-two Treasury yield has fallen 59.5% so far this year and is currently hovering at 0.31%. As we approach zero, the wider market will prepare for a market contraction that normally takes place about three years afterward.
As a result, Gold was on track for its biggest weekly drop in nearly four months on Friday, after demand for the safe-haven metal was hit by hopes of progress in peace talks between Russia and Ukraine as well as the fallout from a U.S. interest rate hike. Bullion is down 2.8% this week as optimism over the peace talks lifted sentiment in wider financial markets, denting demand for safe-haven assets.
However, Standard Chartered analyst Suki Cooper said in a note that the hawkish U.S. central bank did not derail the positive sentiment towards gold and that current geopolitical risk had raised inflation concerns, reigniting longer-term interest in bullion.
COT Report
CFTC data shows expectable performance. Big amount of long position has been closed, open interest has dropped by 8% approximately. At the same time, pay attention that hedgers were not as active with the closing hedges against gold growth.
As a result, net position has changed only slightly:
Source: cftc.gov, charting by Investing.com
Performance of the SPDR Fund shows that investors keep their physical reserves and do not hurry up to unwind them.
Source: SPDR Fund, FPA calculations
The bottom line:
Thus, with all this information above, I would ask you - how bearish is the overall background for the gold market? Let's go with it by points, and take a look at historical Fed fund rate cycles. Particular speaking, the subprime crisis of 2008 and recent CV19 recession. But this pattern holds for other cycles as well - dotcom bubble and 2000's recession that has led to 2nd Iraq war. Upside cycle in general was standing for 3 years (as it is mentioned above) when Fed rises rate for ~4% but later cut it for 5%. And with the cycle of 2008, interest rates has dropped to the zero for the 1st time in history. In most recent recession economy barely was able to absorb 2.25-2.5% rate change and recession starts. While previously 2/10 year spread hits zero area at the end of the cycle - now it already stands there. With this effect of fading interest rates jumping ball, Fed tells that they intend to set "terminal rate" around 2.8% and rise rates until 2024. Additionally they cut 9 Trln. balance sheet that should be treated as additional 0.5% rate hike (according to JP Morgan). Last "easing" cycle has let 2/10 spread to widen just around 1%, which is two times narrower than usual.
Now Fed intends to rise rates until 2024 with the same terminal rate around 2.8%. With forecast of GDP around 2.8% and inflation above 4% - the US economy this year gives negative return and I would ask you - if this is not the recession, what the recession is?
The recession brought on by COVID-19 is fundamentally different than prior downturns, but excessive stimulus, consumer demand, and unforeseen choke points in the global supply chain have brought about similar economic issues. With the Fed raising interest rates this past Wednesday, we have already seen a significant increase in mortgage rates. Freddie Mac said mortgage rates have increased to more than 4% for the first time in almost three years. The expectation for this increase has already cooled off the housing market—the National Association of Realtors (NAR) reported that home sales (existing) fell 7.2% to their lowest total since August 2021.
With a lot of noise around Fed policy, real 30-year interest rates (TIPS) stand in negative territory.
With additional sources of inflation because of geopolitical situation that we've mentioned yesterday in our FX report, and rising overall prices for 20-25%, which are not yet included in statistics. We expect to see this effect somewhere in May. Our suggestion that Fed has started cycle too late and supposedly remains two steps behind inflation. Despite currently data shows good pace of economy, negative effect comes faster than in 2008 and 2020 recessions. Because it was weak supportive effect of recent rate cut, and mostly consumption targets was achieved by uncontrolled money printing. It means that this time the holding effect on economy performance comes faster. Now it is disguised a bit by "robbery of the century" when the US sucks all resources out from the EU. This process should last for few months more, but anyway, we suspect that negative effect of rate change should become evident by the end of 2022. Effect could exacerbated, if nearest 2-3 months will show that Fed rate change is not helpful and inflation doesn't drop. In this case they could rise rate more aggressively, which should accelerate the recession effect. As Pimco said above - "This faster pace of tightening raises the risk of a hard landing further down the road and suggests a higher risk of a recession over the next 2 years."
The analysis of this information makes us think that within few months gold could meet multiple headwinds, as everybody stands in euphoria of the new Fed policy, good economy performance and low unemployment. Demand for the gold hardly disappear totally, as overall situation is tricky and investors keep their possession for the gold. But within few months Fed negative effect will be hidden under the curtain of EU assets flow to the US and temporal relief in geopolitical tensions. Still, consumer sentiment and FNMA data shows that not everything is good, so we do not need even to mention inflation and gasoline prices. Most probable that gold stabilizes in some wide trading range, which also could be treated as accumulation of long term investors.
Later, closer to the end of 2022 upward trend has good chances to continue. This process could accelerate or slow depending on foreign affairs.
Technicals
Monthly
There are still two weeks until March closing and gold still could close below MACDP line, giving another one bearish grabber here. Potentially it suggests downside action to 1700-1750$ area. Speaking in general, the range, that we've mentioned above might be between Pivots levels - 1700-1950$, or even narrower. Now, we the huge "Shooting Star" pattern on the top, monthly technical picture confirms our fundamental conclusion that it would be better to wait a bit with gold investing.
Weekly
Trend stands bullish here and market has completed the minimal reaction on the butterfly pattern, showing 3/8 pullback. Still, as we've got large "Evening star" pattern, it suggests compounded shape of the retracement, which means a kind of AB-CD shape on lower time frame, and deeper target.
Daily
So, above analysis tells that downside action should continue, and daily chart shows as potential targets as the way how it could start. In general, we should get some AB-CD pattern, but the question is, where the "C" point will stand. If price starts dropping right from here, the OP is around 1785$. But intraday charts shows alternative, when "C" point could stay around 1960 area and in this case OP will be around 1805-1830$, making Agreement with major 5/8 support level:
Intraday
First is, we have bullish grabber on 4H chart, which means that we still could get upside AB-CD bounce that we've discussed on Friday. In this case, downside action could re-establish from strong 1H resistance area of 1960$. Thus, on Monday we should keep an eye on 1915$ support. If price holds above it, the next step should be an action to 1965. Thus our plan suggests possible long entry with 1960-1965 target and then downside reversal, following to major daily scenario:
Recent plunge on the gold market looks frustrating for many traders who have counted on unstoppable rally. But with some easing in geopolitical tensions and when military events become routine, despite how cynic it might sounds, the emotional component of the recent rally exhausted. In fact, we should not be surprised with it, as it happens everytime, when some exceptional events are over, but it doesn't mean that we should place the gravestone upon the Gold market. Because of eliminating of emotional component, price drops, but it drops not at the same level as it was a month ago. The financial component of the gold rally is still on the market and sooner rather than later but it finds the way into the price level. Market just needs to find the ground, give investors time to absorb the new reality and shake out some extreme volatility. When the dust settles a bit, market starts reflecting the ongoing processes in the US and global economy.
Market overview
As was widely expected, the U.S. Federal Reserve raised the fed funds rate by 25 basis points (bps) at its March meeting and strongly signaled more hikes to come given a tight labor market and surging inflation. The Fed also released a new Summary of Economic Projections, which shows large upward revisions to the inflation outlook and a significant corresponding pull-forward of more rate hikes into 2022 and 2023.
The outbreak of war in Europe has made a difficult balancing act even more challenging for Fed policymakers as they weigh an uncertain growth outlook against another jump in inflation. However, the Fed signaled that it thinks inflation risks materially outweigh the downside risks to growth, and as a result we expect the Fed to continue its path toward higher rates and a smaller balance sheet. The Fed would likely need to see significant economic slowing and market dysfunction before shifting from its hiking path, as higher and more broad-based price increases further raise the risk that inflation expectations become unanchored. While elevated inflation risks justify a tighter stance of monetary policy, a faster pace of rate hikes will likely weigh on growth over time as financial conditions tighten more abruptly.
Along with the expected policy rate hike, the Fed conveyed an overall hawkish tone in the March FOMC statement and economic projections, as well as in Chair Jerome Powell’s press conference, by making several key changes. First, the Fed added forward guidance to the statement, noting that “ongoing further increases” of the Fed funds rate as well as a reduction in the balance sheet were likely. Second, the Fed had major revisions to the March economic projections relative to the previous forecasts in December 2021. U.S. inflation noticeably outpaced consensus expectations, particularly in January, which combined with additional inflationary impulse from war in Europe, prompted Fed officials to upgrade their inflation forecasts for 2022 by more than 1 percentage point. Officials also penciled in more modest declines in inflation in 2023 and 2024, keeping inflation meaningfully above the Fed’s 2% target over the forecast horizon. (The Fed’s preferred inflation measure is PCE – personal consumption expenditures.)
Consistent with inflation no longer being expected to come back down to target in the forecast horizon and Fed officials seeing inflation pressures as broader based, officials sharply revised their interest rate forecasts higher, and most now expect policy to be above neutral by the end of next year. The median forecast is now for a 1.875% fed funds rate at the end of 2022 (versus 0.875% forecast in December) and 2.750% at the end of 2023 (versus 1.625% previously). Of note, the dot plot shows most officials are forecasting rates somewhat above their median estimate of neutral of 2.4%, suggesting that Fed officials think policy needs to be at least somewhat contractionary to bring inflation back to target.
At the press conference, Chair Powell offered background on these hawkish forecasts while he also sought to preserve optionality to change the policy path as needed in the weeks and months ahead. Similar to his comments earlier this year, Chair Powell did not take the possibility of larger rate increases off the table.
After the Fed concluded its asset purchase program earlier in the month, Chair Powell confirmed our expectations that an earlier and faster start to balance sheet runoff relative to the past cycle will likely be announced at one of the next two meetings. A smaller balance sheet would also contribute to monetary policy tightening this year, and Chair Powell suggested that many officials saw balance sheet runoff as equivalent to an additional rate hike.
By Pimco opinion, looking beyond the March meeting, we expect higher inflation and concerns about inflation expectations to continue to weigh more heavily on Fed officials than downside risks to growth in the coming months. As a result, our baseline forecast remains that there will be rate hikes at consecutive Fed meetings and a meaningful further tightening of policy throughout the year. This faster pace of tightening raises the risk of a hard landing further down the road and suggests a higher risk of a recession over the next 2 years.
Even with the tougher rate increases now projected, the Fed expects inflation to remain at 4.3% this year, dropping to 2.7% in 2023 and to 2.3% in 2024. The unemployment rate is seen dropping to 3.5% this year and remaining at that level next year, but is projected to rise slightly to 3.6% in 2024.
St. Louis Fed President James Bullard, who dissented on this week's action in favor of a half-point increase, said on Friday that officials should raise the Fed's overnight lending rate to more than 3% this year.
The Fed did project the equivalent of quarter-percentage-point rate increases at each of its six remaining policy meetings this year but that was in line with market expectations for rates. After the Fed announced its rate hike decision, benchmark 10-year U.S. Treasury yields reached 2.246%, the highest since May 2019, before retreating to 2.192%. Two-year note yields rose to 2.002%, further flattening the closely-watched yield curve.
One generally accepted, forward-looking indicator for a recession has been the 10-two Treasury yield spread. When this figure becomes inverted, market participants are no longer incentivized to invest in longer-dated securities since short-term issues provide the same yield and similar risk. The 10-two Treasury yield has fallen 59.5% so far this year and is currently hovering at 0.31%. As we approach zero, the wider market will prepare for a market contraction that normally takes place about three years afterward.
As a result, Gold was on track for its biggest weekly drop in nearly four months on Friday, after demand for the safe-haven metal was hit by hopes of progress in peace talks between Russia and Ukraine as well as the fallout from a U.S. interest rate hike. Bullion is down 2.8% this week as optimism over the peace talks lifted sentiment in wider financial markets, denting demand for safe-haven assets.
However, Standard Chartered analyst Suki Cooper said in a note that the hawkish U.S. central bank did not derail the positive sentiment towards gold and that current geopolitical risk had raised inflation concerns, reigniting longer-term interest in bullion.
COT Report
CFTC data shows expectable performance. Big amount of long position has been closed, open interest has dropped by 8% approximately. At the same time, pay attention that hedgers were not as active with the closing hedges against gold growth.
As a result, net position has changed only slightly:
Source: cftc.gov, charting by Investing.com
Performance of the SPDR Fund shows that investors keep their physical reserves and do not hurry up to unwind them.
Source: SPDR Fund, FPA calculations
The bottom line:
Thus, with all this information above, I would ask you - how bearish is the overall background for the gold market? Let's go with it by points, and take a look at historical Fed fund rate cycles. Particular speaking, the subprime crisis of 2008 and recent CV19 recession. But this pattern holds for other cycles as well - dotcom bubble and 2000's recession that has led to 2nd Iraq war. Upside cycle in general was standing for 3 years (as it is mentioned above) when Fed rises rate for ~4% but later cut it for 5%. And with the cycle of 2008, interest rates has dropped to the zero for the 1st time in history. In most recent recession economy barely was able to absorb 2.25-2.5% rate change and recession starts. While previously 2/10 year spread hits zero area at the end of the cycle - now it already stands there. With this effect of fading interest rates jumping ball, Fed tells that they intend to set "terminal rate" around 2.8% and rise rates until 2024. Additionally they cut 9 Trln. balance sheet that should be treated as additional 0.5% rate hike (according to JP Morgan). Last "easing" cycle has let 2/10 spread to widen just around 1%, which is two times narrower than usual.
Now Fed intends to rise rates until 2024 with the same terminal rate around 2.8%. With forecast of GDP around 2.8% and inflation above 4% - the US economy this year gives negative return and I would ask you - if this is not the recession, what the recession is?
The recession brought on by COVID-19 is fundamentally different than prior downturns, but excessive stimulus, consumer demand, and unforeseen choke points in the global supply chain have brought about similar economic issues. With the Fed raising interest rates this past Wednesday, we have already seen a significant increase in mortgage rates. Freddie Mac said mortgage rates have increased to more than 4% for the first time in almost three years. The expectation for this increase has already cooled off the housing market—the National Association of Realtors (NAR) reported that home sales (existing) fell 7.2% to their lowest total since August 2021.
With a lot of noise around Fed policy, real 30-year interest rates (TIPS) stand in negative territory.
With additional sources of inflation because of geopolitical situation that we've mentioned yesterday in our FX report, and rising overall prices for 20-25%, which are not yet included in statistics. We expect to see this effect somewhere in May. Our suggestion that Fed has started cycle too late and supposedly remains two steps behind inflation. Despite currently data shows good pace of economy, negative effect comes faster than in 2008 and 2020 recessions. Because it was weak supportive effect of recent rate cut, and mostly consumption targets was achieved by uncontrolled money printing. It means that this time the holding effect on economy performance comes faster. Now it is disguised a bit by "robbery of the century" when the US sucks all resources out from the EU. This process should last for few months more, but anyway, we suspect that negative effect of rate change should become evident by the end of 2022. Effect could exacerbated, if nearest 2-3 months will show that Fed rate change is not helpful and inflation doesn't drop. In this case they could rise rate more aggressively, which should accelerate the recession effect. As Pimco said above - "This faster pace of tightening raises the risk of a hard landing further down the road and suggests a higher risk of a recession over the next 2 years."
The analysis of this information makes us think that within few months gold could meet multiple headwinds, as everybody stands in euphoria of the new Fed policy, good economy performance and low unemployment. Demand for the gold hardly disappear totally, as overall situation is tricky and investors keep their possession for the gold. But within few months Fed negative effect will be hidden under the curtain of EU assets flow to the US and temporal relief in geopolitical tensions. Still, consumer sentiment and FNMA data shows that not everything is good, so we do not need even to mention inflation and gasoline prices. Most probable that gold stabilizes in some wide trading range, which also could be treated as accumulation of long term investors.
Later, closer to the end of 2022 upward trend has good chances to continue. This process could accelerate or slow depending on foreign affairs.
Technicals
Monthly
There are still two weeks until March closing and gold still could close below MACDP line, giving another one bearish grabber here. Potentially it suggests downside action to 1700-1750$ area. Speaking in general, the range, that we've mentioned above might be between Pivots levels - 1700-1950$, or even narrower. Now, we the huge "Shooting Star" pattern on the top, monthly technical picture confirms our fundamental conclusion that it would be better to wait a bit with gold investing.
Weekly
Trend stands bullish here and market has completed the minimal reaction on the butterfly pattern, showing 3/8 pullback. Still, as we've got large "Evening star" pattern, it suggests compounded shape of the retracement, which means a kind of AB-CD shape on lower time frame, and deeper target.
Daily
So, above analysis tells that downside action should continue, and daily chart shows as potential targets as the way how it could start. In general, we should get some AB-CD pattern, but the question is, where the "C" point will stand. If price starts dropping right from here, the OP is around 1785$. But intraday charts shows alternative, when "C" point could stay around 1960 area and in this case OP will be around 1805-1830$, making Agreement with major 5/8 support level:
Intraday
First is, we have bullish grabber on 4H chart, which means that we still could get upside AB-CD bounce that we've discussed on Friday. In this case, downside action could re-establish from strong 1H resistance area of 1960$. Thus, on Monday we should keep an eye on 1915$ support. If price holds above it, the next step should be an action to 1965. Thus our plan suggests possible long entry with 1960-1965 target and then downside reversal, following to major daily scenario:
