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Gold threatens to break December lows

By David Morrison  |  11/07/2018 14:27
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Gold is out of favour with investors. This is despite inflation-adjusted interest rates making it an attractive safe-haven in an uncertain world
 
Just over a week ago gold broke below $1,240 to hit its lowest point for the year so far. It managed a quick, if uneven, recovery and briefly pushed above $1,265 on Monday. However, it has drifted lower since then and the danger is that it could easily break below the sub-$1,240 low seen in December last year.

The main reason that gold has been under pressure is the expectation that the US Federal Reserve will continue to raise rates this year and next. The smart money is split over whether the Fed will hike by an additional 25 or 50 basis points by the end of 2018. But either way, it looks as if there’s further tightening to come, possibly taking the fed funds into a range of 2.25-2.50%, up from 1.75-2.00% currently. Higher US interest rates are bad for the dollar price of gold (which is generally viewed as a yield-free asset) as investors spurn the metal in favour of yield-bearing assets such as US Treasuries, or dividend-paying stocks. However, tighter monetary policy is only part of the story. What really matters for gold is what the ‘real’ rate of interest is, rather than the nominal. The ‘real’ rate takes inflation into account. In other words, how much interest would an investor receive once inflation is subtracted. Now it’s perfectly correct that US interest rates are the highest in the developed world, and look set to go higher. But inflation is also picking up. We’ve just heard that the Fed’s preferred inflation measure, Core PCE, has hit the US central bank’s 2% target. Meanwhile, Headline CPI is running at 2.8% and some unofficial inflation indices are even hotter. What this means is that by some measures real yields are negative. Inflation is eroding the Fed’s 2% interest rate, and if we consider Headline CPI it’s also not covering the 2.3% yield on a US 1-year bill.

At the same time the Fed has said that it is prepared for inflation to overshoot it’s 2% target, given the length of time it’s been below here. This suggests that the central bank won’t suddenly accelerate the pace of monetary tightening just because prices start to pick up.

Despite all this, gold is out of favour with investors. Looking at the charts, a break of the December 2017 low raises the possibility of a pull-back to $1,200. But the MACD has just turned higher and there is some chatter that we’re overdue a bounce. Much will depend on where the dollar goes from here. If the greenback resumes its rally from mid-April then we should expect gold to struggle. But if US inflation continues to pick up and the Fed indicates that it may hold off from raising rates in September (possibly because trade issues escalate) then gold may once again resume its status as the ultimate safe-haven.

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