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Has Gold Hit Bottom, Finally?

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Gold prices continued their September fall into October. That is, until the ADP reported a surprise drop in the number of people hired. That brought at least a temporary end to the largest losing streak for the precious metal since 2017.

Interestingly, the lower gold prices were thanks to a similar phenomenon as to what happened nearly seven years ago. Higher interest rates drove away demand for gold. But, eventually the Fed was forced to end their rate hiking campaign, and after 2018 gold prices rebounded to eventually more than double what they were. Can history repeat itself?

The reasons for the move

Despite the Fed saying it was almost done with the rate hikes, Treasury yields have continued to rise over the last several weeks. So high that they peaked out at a 16-year high earlier this week, and Fed officials started commenting on them. San Francisco Fed President Mary Daly on Thursday got attention for remarking that rising yields were equivalent to a quarter-point rate hike. That could mean that the Fed might not go through with a final tightening of monetary policy this year.

The logic for the move in the price of gold is that higher yields make the dollar stronger. Since gold is priced in dollars, its comparative price goes down. But also, higher interest rates make it more profitable to hold bonds that pay interest. Gold holdings don’t pay interest, which means they are comparatively less attractive. Particularly in an environment where inflation is coming down, the store-of-value appeal for gold also wanes.

Why now?

The rise in yields finally affecting gold seems to have curious timing, since the Fed is pretty much done with the rate hikes. But that’s because the market is not shifting from what was generally seen as a low-rate environment, to understanding that higher interest rates will be around for a long time.

Many economists thought that the Fed would be forced to cut rates soon as the US slipped into a recession. But the latest data suggests that the US economy has been more resilient than expected. If a hard landing is avoided, then the Fed can keep rates higher at a time when the Federal government is expected to issue a large amount of debt to pay for accumulated spending mandates.

The bill comes due eventually

In the period after the dot-com boom, the Fed kept rates low for an extended period of time, resorting to even buying up trillions in debt. That provided an almost unlimited backstop in bond-buying, so the sovereign rating issue was not factored into the interest rate charged on bonds. But now that the Fed is selling bonds instead of buying them, investors have to consider how much demand there is for debt when appraising bonds. With higher risk that there will be fewer buyers in the future, bond buyers are demanding higher yields in compensation. This is forcing up yields, supporting the dollar and weighing on the price of gold.

A sudden shift in the data that could mean the US will have a harder than expected landing might derail the current outlook. Or anything to suggest the Fed might have reasons to lift rates sooner, such as a deteriorating labor market or inflation falling significantly faster than expected.

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