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Gold, New Records Ahead?

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Gold trending higher through the week, largely driven by weaker US Treasury yields. As it approached a two-week high, it was short of the May 10 record. But the positive performance has opened the question of whether the yellow metal can hit new record highs in the near future.

US yields were lower in the lead-up to NFP, as the broad consensus was that the jobs numbers would show continuing loosening in the labor markets. That would be a predicate for the Fed being inclined to ease, as it would be less worried about a rebound in inflation. The market is still pricing in no rate hike at next week’s FOMC meeting, with the focus still on September.

Next Week Could be Crucial

Even though there is a near-universal consensus that there will be no change at the FOMC meeting, next Wednesday the markets could be roiled up substantially. And gold might be among the most affected. That’s because in an uncommon coincidence, US inflation figures for May will come out while the FOMC members are discussing what to do with interest rates. And it will be just a few hours before the rate decision is announced.

The projections at the moment are for a pretty razor-thin margin for inflation data that opens the possibility of a relatively small beat disappointing markets. Meanwhile, a minimal miss could end up reassuring markets substantially. That’s because the forecast is for headline inflation to remain unchanged. So, just one decimal higher would mean that the downward trend is shattered, and markets could be really worried about the September rate cut. But one decimal of miss would affirm two months of decreasing inflation, and affirm the narrative for the Fed’s easing.

Tracking the Yields and Gold Rises

Gold, of course, typically performs in opposition to bond yields. With the consensus being that the Fed will eventually ease this year, bond yields are expected to trend lower over the coming months. That would put substantial buoyancy under the price of gold.

But there are other factors that imply further upside, as well. One is the continued aggressive buying by central banks, even when prices are higher. In the first quarter of this year, central banks bought a record amount of gold for their reserves. They bought even more in April, suggesting that higher prices are not holding back large institutional demand. With gold production expected to be largely flat through the rest of the year, the increased demand would likely put upward pressure on prices.

But, the Black Swan?

Of course that doesn’t mean gold prices are guaranteed to rise. The yield curve remains inverted, and there is still a potential of an economic reversal that could drag on gold’s performance. Gold EFTs have suffered outflows while bullion has seen increasing demand, a sign that investors are moving towards insulating against potential market shocks.

Barring the unexpected, the confluence of high inflation while interest rates are set to lower, plush simmering geopolitical tensions is a recipe for stronger gold. And even an adverse economic event might only be a temporary halt to gold’s long-term upside.

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