What's next for gold?

Traditionally higher interest rates imply lower prices for gold; but with increasing talk of a recession, that might not be the case this time around.

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What's driving the market

Gold spiked to its most recent high following Russia's invasion of Ukraine and the threat of default after Western countries froze its foreign reserves -- the classic risk-aversion move. But since mid-April it has been sliding. Gold is now back to where it was before the general public started getting really worried about imminent hostilities in Ukraine.

The simple answer is monetary policy, given that the Fed just raised rates by 50 bps for the first time since 2000 and is on the route to the most aggressive tightening policy since 1988. The data bears out this approach, since the real yield on the 10-year US Treasury hit break-even for the first time since the start of the pandemic. What this means is that for the first time in two years, the expected return on holding bonds turned positive, when taking into account inflation.

Flight to profit

With low interest rates and high inflation, it makes sense to store value in gold. But when interest rates go above expected inflation, owning gold takes on an opportunity cost. However, that supposes that interest rates will remain elevated, and inflation will go down. If investors are more optimistic, and looking to take on risk, they will be less inclined to invest in bonds. And even less inclined to invest in gold.

But, the VIX has been moving higher in that same period, suggesting that traders are not feeling more optimistic. It was highly speculated that the Fed would start drawing $95B in liquidity from the market, but in the end decided to go for just half of that. This naturally has a distorting effect on the market, which could depress gold in the short term. But if inflation doesn't start coming down as anticipated, real yields could slip back into negative. Meaning gold could have another opportunity to move higher.

Gold near 200-day average

Gold has come under pressure since prices weakened below its 50-day average of $1949/oz (currently at $1941/oz). Despite having entered a bull market in January ‘22, the commodity is likely to test the 200-day average at $1845/oz. This increases the risk of a breakdown.

Coincidently, the major SMA lies at the same price as the ascending trendline that rejected bears and back in January, leading to the bull market. This makes $1955/oz a strong support. However, we have recently re-entered the $1750-$1870 range, adding a bit to the downside bias. In case the support is lost, major support can be observed at the bottom of the range. In the interim, $1800/oz makes good support. But if the support holds, a relief rally towards the 50 SMA could be seen.

Source: Spreadex trading platform

Key Takeaways

Gold had a steep rise following Russia's invasion of Ukraine, but since then it has been falling largely due to the Fed's tightening. Some investors are less likely to invest in gold in the near future because interest rates are expected to stay high. Gold may be more at risk of a price decrease in the short-term due to Fed’s decision to take less liquidity from the market, but if inflation fails to come down as anticipated, it may have another opportunity to move higher.