The tight range reflects the modest weakening in the US dollar since the beginning of the year, and large equity market down moves in which gold caught a bid. The catalyst for this equity market weakness was the rise in both short and long-term interest rates, particularly in the US. Two-year yields in the US rose above 1% and ten-year yields climbed to levels of around 1.85% – the highest in two years. Gold has traded quite strongly, considering – although this is likely also explained by commodity index rebalancing, which normally starts in January.
Yields have increased because the US Federal Reserve has adopted a distinctly hawkish narrative, moving to increase the pace of its QE tapering programme and to begin outright balance sheet reduction in the summer. Markets have also priced in nearly four rate hikes this year. The Fed’s forthcoming 26 January meeting will be important in that it will give investors more understanding about the prospects for a March rate hike.
Normally, tighter monetary policy is bad news for gold – higher nominal and real interest rates tend to reduce its attractiveness as it is a non-yielding asset. However, gold has held up well so far, because inflation has been stubbornly high. We anticipate that inflation should begin to fall from the second quarter onwards, meaning that real rates will start to rise. This is an ominous development for gold, and investors will have to keep a close eye on this factor. Consequently, we think that gold should not have too much upside potential over the coming weeks – we think Fed speakers will talk up the chances of a faster and more aggressive rate-hiking cycle than markets currently expect, which has clearly negative implications for the yellow metal.
Investors are still maintaining a large long gold position, both in ETFs and in the futures market. ETF holdings have risen from pre-pandemic levels of around USD 7 trillion to around USD 9.7 trillion now, suggesting that investors may reallocate portfolios away from gold once the outlook for rates and inflation becomes clearer. If this manifests itself, it has clear downside risk for gold, probably to levels of around USD 1,700 per ounce.