Forex Trading Library

Is It Time for Gold to Take Off?

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Last week, gold trended higher in the wake of weaker US data. It wasn’t just gold, but the whole of the base metals complex were upbeat as well, with silver and platinum going higher. Part of that could be explained by weakness in the dollar in anticipation of the jobs numbers at the end of last week. And then got an extra boost following weaker-than-expected NFP.

The dollar weakness naturally is due to fundamentals. But we can’t ignore a particular technical phenomenon from last week as well. Towards the end of June, bond yields rose as a bunch of options expiries came up with the end of the quarter. The subsequent drop in yields implied a certain amount of returning to normal for the bond markets. And those lower bond yields implied upside for gold.

What Else is Driving the Market?

It’s not just precious metals that have been upbeat, but commodities in general. Weather conditions have played a part, as well. The surprisingly strong hurricane for this season hitting Texas contributed to risk aversion. Additionally, record high temperatures in resource-rich areas have slowed production. Drought is a significant worry for metals producers who need a lot of water to process out ores. That can be particularly true for gold, which has low concentrations in the Earth.

Meanwhile, gold demand isn’t going anywhere. In fact, it seems to be growing. The first quarter saw record buying of gold among retailers, and central banks kept up buying the yellow metal at a rate well above the prior years’ average. The second quarter is shaping up to have a similar amount of strong demand. Meanwhile, the high price has attracted more recycling of gold, meaning that inventories are running down.

It’s a Spending Problem

Interestingly, money is flowing out of spot gold ETFs, but is more than offset buy buyers of physical gold. That points to markets potentially being more worried about geopolitical risks, as illustrated by the large buying of bullion by institutions. So far, supply has been able to keep up with gold demand, but there aren’t any new major gold production facilities expected to come online in the near future. It could take years for a higher price in gold to push miners into further exploration and increasing supply.

Analysts are predicting gold to go higher as increasted government spending around the globe is set to keep inflation elevated. Price targets as high as $2.700/oz by next year have been floated.  The recent left-wing electoral victories in the UK and France with promises to increase government spending, and reach the limit of debt issuance, has rekindled inflation fears.

But Lower Rates?

Investors are likely to keep gold upbeat if they are worried about inflation. But high inflation would imply central banks might keep rates higher for longer. Which would be the case if the respective economies remain bouyant. But high inflation from government overspending cannot be counteracted by monetary policy without crashing the economy – which is also positive for gold.

While the path for gold going higher appears to be clearing, obstacles to the downside appear to be growing. It would take a growing economy with limited inflation, while geopolitical tensions ratchet down. That would be a hard trick to pull off at this point.

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