Gold Sleeps And Drifts Lower- The Catalysts That Could Ignite The Precious Metal
Gold futures on the CME’s COMEX division reached a record high of $2,072 per ounce in March 2022, slightly eclipsing the August 2021 $2,063 previous all-time peak. The ascent of gold futures began in 1999 when the price found a bottom at $252.50 per ounce during the UK’s sale of half the country’s reserves. While the UK sold a significant percentage of its holdings, other countries did not follow. Over the past twenty-two years, countries, central banks, and monetary authorities worldwide have been net buyers of the metal, validating its role in the global financial system.
At the $1,745 level on the active month December COMEX futures on August 30, gold has corrected 15.8% from the March 2022 high. However, the price remains seven times higher than the 1999 low, and the prospects are for even higher highs over the coming months and years.
A correction takes gold lower, but the long-term pattern remains bullish
While the gold price dropped by nearly 16% over the past five months, the long-term trend remains bullish.
As the chart highlights, the pattern of higher lows and higher highs since 1999 remains intact as gold traded to a low of $1679.80 in July 2022, higher than the $1673.70 low from March 2021. Gold stopped falling at the correct technical level after the March 2022 high, but higher interest rates and a strong US dollar continue to weigh on the price in late August.
Russia’s declaration could start a trend in the gold market
Facing the US and European sanctions after Russia invaded Ukraine, Moscow decided to back 5,000 roubles with one gram of gold. Backing the Russian currency with gold caused it to rise against the US dollar. Meanwhile, the dollar’s value has increased against the euro and other reserve currencies over the past months.
The chart illustrates the upward trajectory of the dollar index, which measures the US foreign exchange instrument against the euro, pound, yen, Canadian dollar, Swedish krona, and Swiss franc.
The Russian rouble has strengthened against the US dollar since the March 2022 low. The rouble is trading at the highest level against the US dollar since early 2018 and reached a seven-year peak in June 2022. The strong rouble is a sign that the implied backing with gold has strengthened the Russian currency.
The geopolitical arena supports higher gold
The February “no limits” agreement between Russia and China creates bifurcation between the world’s nuclear powers. Deteriorating relations between China/Russia and the US/Europe impacts trade and threatens world peace. While a tense geopolitical landscape supports gold, Russia’s move to back its currency with the precious metal could be a gateway for China to follow.
Over the past years, Russia and China have been high-profile gold buyers, adding to reserves. Since Russian and Chinese stockpiles are state secrets, it is impossible to identify just how much gold the countries purchased. However, since China is the world’s leading gold producer and Russia is third behind Australia, a significant percentage of annual output is likely flowing into the countries’ reserves.
China has the second-leading economy, and the potential for backing the yuan with gold could significantly impact fiat currency values and the path of least resistance for gold over the coming years. The bottom line is the geopolitical landscape supports a higher gold price.
Inflation and/or recession could ignite the price
Gold is an inflation barometer, but the monetary tools to control the economic condition are bearish for the metals price. Rising US interest rates increase the cost of carrying long gold positions and make fixed-income investments more attractive. Moreover, higher US interest rates support the US dollar, which rose to a two-decade high over the past weeks. A rising dollar tends to weigh on the gold price.
Meanwhile, two consecutive quarters of US GDP declines is the textbook definition of a recession, and rising interest rates only increase recessionary pressures. Throughout most of 2021, the US central bank and administration called inflation a “transitory” event, blaming it on supply chain bottlenecks and pandemic-inspired factors. In late 2021, they had an epiphany, and now, fighting inflation is their primary goal. In 2022, the Fed and administration are calling declining GDP a “transition” instead of an economic decline. With the mid-term elections on the horizon, “transition” is a politically correct description they hope will resonate with voters.
After falling asleep at the wheel on inflation in 2021, the Fed and Washington DC could be doing the same regarding economic contraction in 2022. In his latest speech on Friday, August 26, Fed Chairman Jerome Powell reiterated the commitment to fighting inflation with monetary policy, saying higher interest rates “are the unfortunate costs of reducing inflation.”
In another sign that the Fed may reserve course despite the Chairman’s latest comments, the July US personal consumption expenditures (PCE) index rose by 6.3%, under the 6.8% rise in June, and far less than the July consumer and producer price index data. Inflation is coming down, and the Fed will continue to attempt to push it to the 2% target level. However, the medicine for inflation may only exacerbate the recessionary pressures, causing the need for a more dovish approach in 2023, which would support gold’s price.
Gold is a hybrid- More volatile than currencies, but less price variance than commodities
Gold walks a fine line between a financial and commodity or industrial asset. Price variance in the gold market is higher than in currencies but lower than in commodities.
The chart shows twenty-year historical volatility in gold at the 9.26% level.
The metric in the dollar index is lower at 5.07% over the same period
In the crude oil futures market, a leading industrial commodity, the historical price variance metric is at 35.98%, far higher than in gold.
Gold is unique, and the world’s governments validate its position in the financial system. While the world’s leading economy continues to battle inflation with hawkish monetary policy, ignoring the rising recessionary wave could plant the seeds for the next move to a higher high in the over two-decade-long gold bull market.