Gold (XAU/USD) Fundamental Forecast: Slightly Bearish
A return to the bullish Fed narrative drives USD, weighs on goldUS non-farm payroll miss throws the Fed another curveball – possible tailwind for gold?
Omicron Induced Volatility
After a rather volatile week gold is on track to finish the week within 1% of its opening level (at the time of writing). This, despite witnessing sizeable daily moves and trading well above $1800 reflects the underlying market sentiment of the last week. As a result, the gold volatility index reached an 8 month high as shown below:
Gold Volatility (.GVZ) Compiled by the CBOE
Source, Refinitiv, CBOE
Initial fears of the Omicron variant on Friday the 26th boosted the value of the yellow metal due to its inverse relationship with treasury yields, with the 10 year yield dropping around 23 basis points from Monday to Wednesday. Likewise, the US dollar traded lower over the same period which further elevated gold prices due to the metal being priced in dollars. Markets essentially repricing the dollar which had already priced in three rate hikes for 2023.
As the week progressed early anecdotal evidence regarding the mild nature of symptoms generally observed in patients reached the newswires, somewhat putting markets at ease. Thereafter, gold moved lower which could be telling about how markets perceive the yellow metal and the future path of interest rate hikes which is ultimately to golds detriment.
How Much Longer will Gold Maintain its Luster?
Gold has thrived in arguable one of the most bullish environments in recent times as nominal interest rates in major economies approached zero, turning real interest rates negative. The real interest rate is the result of subtracting inflation from nominal interest rates and provides an indication of purchasing power when investing in interest bearing investments.
Up until this year, inflation had been extremely low due to the lack of economic activity on the back of the global lockdowns and rates were zero, or close to zero; meaning the reward for investing in a money market account or similar interest-bearing investment provided a zero or negative real return. Gold, a non-interest bearing asset, then starts to look comparatively better as those with exposure to the metal can benefit from price appreciation at a time when the future prosperity of the global economy was extremely uncertain and real rates of return in other investments looked unappealing.
With soaring inflation, real yields remain in negative territory but financial markets will eventually price in the expectation of future interest rate hikes which will weigh on the price of gold.
Real Yields Interpolated from Treasury’s Daily Yield Curve (A Measure of Real Interest Rates), US 5 and 10 year
Source: US Treasury, Nasdaq.com
Fast forward to today and we are witnessing central bank rate hikes in New Zealand, South Africa, Russia and Poland with major central banks like the Bank of England considering a hike in December or early next year. 2022 and 2023 currently marks the timeframes in which major central banks are anticipating rate hikes which will once more elevate the attractiveness of interest bearing investments at the expense of gold. Therefore, it is clear that gold will face significant price pressure but the question of when this will happen still remains to be seen and with current volatility and uncertainty, a move higher is also not out of the picture.
For now spot Gold rests on a significant weekly level corresponding with the 23.6% Fib level (August 2020 high to August 2021 low) at around $1763 which could act as a springboard for higher prices if respected. The Fed could make mention of recent NFP miss as justification for remaining cautious but the more important unemployment figure of 4.2% is now well below the 4.5% identified in previous addresses. Therefore, this scenario may be less likely.
Alternatively, a test and break of the $1763 level remains possible if rates markets bet on an aggressive tapering timeline in an attempt to cool persistently rising inflation.
Spot Gold Weekly Chart
Chart prepared by Richard Snow, IG
—-Written by Richard Snow, Analyst at DailyFX
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