Headwinds for gold ahead of FOMC
By Ole Hansen, Head of Commodity Strategy, Saxo Bank
Gold trades near a ten-week low ahead of Wednesday’s FOMC which is expected to yield an accelerated pace of rate hikes with the market pricing in a 50 basis point lift while the risk of a 75 basis point jump has also been entertained by some analysts. A surging dollar, up more than 6% against a broad basket of currencies since the start of the year, and a continued rise in US bond yields, have all helped send the price lower. In part driven by short-term technical selling by hedge funds and CTA’s.
From an absolute performance perspective a 1.5% year-to-date return in dollars at a time of surging inflation seems less than impressive. However when adding the tumble seen across stocks and bonds, an investor having diversified part of his portfolio to gold has little to complain about. Even less so for a non-dollar based investor who have seen a sharp divergence between gold and the mentioned asset classes.
The table below shows how a dollar-based investor has achieved a 14.2% outperformance relative to the S&P 500 and 22.2% versus an ETF tracking long duration US bonds. Across the big pond in Europe, an investor would have seen a 22.2% outperformance against the Euro Stoxx50, a pan-European stock index, and 19.3% against an ETF tracking European government bonds.
The latest weakness which gathered some momentum following Friday’s failed attempt to break above $1920/oz has been driven by a renewed rise in US ten-year real yield into positive territory for the first time since early 2020. Comparing gold and real yields at the current level at +0.12% you could argue that gold is theoretically overvalued by close to 200 dollars.
However, as we have seen in recent months, demand for gold, especially through ETF’s have remained robust during the period of rising real yields. Primarily due to re-allocations by asset managers looking for a hedge against a policy mistake, i.e., the FOMC hikes until the economy breaks, elevated volatility in stocks and bonds and a prolonged period of elevated inflation sapping the outlook for several sectors of the stock market.
These drivers have not gone away, but the sharply higher dollar against both the Indian Rupee and Chinese Renminbi, the world's biggest buyers of physical gold may trigger a challenging period for gold, until buyers adapt to higher levels, something that is likely to trigger some pent-up demand, especially in India.
Another worry is Russia and its central bank which holds a major percentage of its reserves in gold. As the unjustified and ill-conceived idea to wage war against a sovereign nation eats into its reserves, the market worry Russia would have to start sell some of their gold. Not least considering it can no longer access the euros and dollars held at private institutions and central banks in the U.S. and Europe.
At the March G7 meeting in Brussels, the group said it would continue to work jointly to blunt Russia’s ability to deploy its international reserves to prop up Russia’s economy and fund Putin’s war. They also specifically said that any transaction involving Central bank held gold would be covered by existing sanctions. That would leave India and China as the two major venues for any undercover sales of gold, a risk we see as being limited, at least at this stage.
From a technical perspective gold needs a break above $1920 in order to force buying from holders of recently established short positions while key support below $1850 on the Comex Gold future is in a band towards $1830. Only a break below that level would begin challenging our bullish view on gold as highlighted in our quarterly outlook.
