Is the bottom for precious metals in?

Precious metals have been tracking higher, though guided by a weaker dollar. Could the trend continue into the new year?

Year-end risk appetite

A gold rally, particularly in the final months of the year, is typical. There is demand for the holidays, wedding season in India, and portfolio rebalancing. But the latest rally in precious metals correlates much closer to the dollar weakening around 8.5% since the start of November. In the same period, gold increased slightly by over 10%.

Where the dollar goes could be the key to where the price of precious metals goes. And that likely has more to do with generalised risk appetite, with investors selling dollars and looking for a return on investment. There are likely two critical factors to push the dollar:

1) China's reopening;
2) Fed's potential pivot.

If the long-feared recession materialises and leads investors back to the safety of the dollar, the rise in precious metals could come to a halt.

Inflation vs profits

Dollar strength has relied on the expectation that the Fed would raise rates and bring inflation down. That spurred demand for treasuries since it meant they offered a better real rate of return than other currencies with higher inflation and/or lower rates. But, there is considerable debate as to whether the Fed will keep rates high if a recession starts to bite.

If the Fed manages to resist political pressure to cut rates, the dollar could remain elevated through the year at the cost of precious metals. But if it appears likely the Fed could give in, cut rates or restart QE to prop up the economy, then gold could become very much in demand as a hedge against an expected resurgence of inflation. In the short-term, what the Fed might signal following its December 14 meeting would likely set up directionality through the end of year trading.

Gold validates pennant

Gold prices have exited the bearish trend for now after breaking past the upper channel trendline near the 1700/oz handle. Then, prices formed a pennant, extending to $1810/oz. Typically, pennants spiral the length of their first leg, which might bring prices up to $1950/oz (R2), provided the $1885/oz (R1) resistance fails to hold bulls. Above there lies the $2000/o (R3) wall. Inversely, $1740/oz (S2) is the medium-term make-it- or break-it level, with the $1700/oz (S3) as some sort of last resort. However, $1780/oz (S1) is short-term support above there.

Key takeaways

Gold prices have been rising recently, correlated with a weakening dollar. This rally is typical for the end of the year due to increased demand from holidays and the wedding season in India, and portfolio rebalancing. However, the dollar's strength relies on China's reopening and the Fed's potential pivot. If the Fed appears likely to cut rates, then gold could become very much in demand as a hedge against an expected resurgence of inflation. But if the long-feared recession materialises and leads investors back to the safety of the dollar, the rise in precious metals could come to a halt.