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Gold hits August ‘21 lows as Fed hike expectations spike: Could the metal drop further?

By Piero Cingari

15:49, 15 September 2022

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Gold
Gold
1783.93 USD
12.75 +0.720%
DXY
US Dollar Index
104.9921 USD
-0.254 -0.240%
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gold bars and downward trend
Gold prices falling in a bearish market. Red arrow going down over gold bullion bars. – Photo: Shutterstock

In my latest piece, "Gold price analysis: Brace for a rate shock as inflation runs amok", I noted that a fresh spike in Fed rate hike expectations could have pushed gold to test its yearly lows.

This risk materialized on September 15 and gold fell below the crucial year-to-date low of $1,680 per ounce, hitting an intraday low of $1,663/oz exactly equal to the bottom seen in August 2021.

Gold is now on the verge of entering a bear market, having fallen 19.4% from its peak on March 8, 2022.

The move was prompted by the release of August inflation data (8.3% year on year), which exceeded market expectations (8.1%) and prompted investors to bet on a more aggressive Fed in rate hikes. Gold has once again been hit by spike in the US dollar (DXY) and US Treasury yields.

The market is now fully pricing in a 75 basis point increase at the Federal Reserve meeting next week, and also discounting with a 20% probability a rise of a full percentage point.

So, where do we go from here? Is a there a floor for gold prices or is the metal doomed to a slow and unstoppable decline?

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Chart: Gold at its lowest since August 2021, flirting with a bear market

A chart showing gold prices and drawdown from peakGold (daily) price chart as of September 15, 2022 – Photo: Capital.com, Source: Tradingview

Gold fundamental analysis: Real yields in command

This week, US real yields rose to 1%, the highest since December 2018, while gold fell to its August 2021 lows.

This is not by chance. Gold prices are inextricably linked to the fate of US real rates. Higher real yields reflect a stronger Fed hawkishness and act as a deterrent to investing in non-yielding assets such as gold.

The correlation between gold and US real yields is currently very strong and inverse (-0.89).

Can real yields keep climbing and gold keep dropping from here?

a chart showing gold vs US real yieldsGold vs US real yields (10-year), high and inverse correlation – Photo: Capital.com, Source: Tradingview

The more the Fed indicates its intention to hike interest rates, the higher real yields rise, driving down the price of gold.

Gold

1,783.93 Price
+0.720% 1D Chg, %
Long position overnight fee -0.0061%
Short position overnight fee 0.0025%
Overnight fee time 22:00 (UTC)
Spread 0.18

Oil - Crude

72.99 Price
-2.200% 1D Chg, %
Long position overnight fee -0.0157%
Short position overnight fee 0.0013%
Overnight fee time 22:00 (UTC)
Spread 0.03

Silver

22.64 Price
+1.970% 1D Chg, %
Long position overnight fee -0.0062%
Short position overnight fee 0.0023%
Overnight fee time 22:00 (UTC)
Spread 0.020

Oil - Brent

78.09 Price
-2.140% 1D Chg, %
Long position overnight fee -0.0216%
Short position overnight fee 0.0061%
Overnight fee time 22:00 (UTC)
Spread 0.04

If the Federal Reserve intends to continue raising interest rates for an extended period of time, gold prices have not yet reached rock bottom.

The dollar becomes more attractive when interest rates and Treasury yields rise, thereby reducing the investment demand for gold.

However, there is a point at which further expectations of an increase in interest rates might lose their ability to exert downward pressure on gold prices. Gold's negative relationship with interest rates may decouple in two particular economic scenarios.

Is there any bullish fundamental case for gold?

Gold's recovery in the medium term is based on two possible macroeconomic scenarios.

  1. A recession characterised by falling inflation
  2. A prolonged stagflation

In the first scenario, further strong rate increases would inevitably cause the economy to enter a recession. If this is accompanied by falling inflation, the Fed will be compelled to stop or reverse its rate hike path, which will benefit all assets that are extremely sensitive to Fed rates, such as gold or the Nasdaq 100 as explained here

In a context of prolonged stagflation, which is defined as low growth and high inflation. gold could resurrect and act as a traditional inflation hedge since gains offered by Treasury yields or the US dollar may no longer be sufficient to offset the prospect of higher inflation and lower growth. 

In order for this scenario to play out, investors must support the idea that inflation may continue to outpace Treasury yields for a longer period of time. This would result in a massive rotation away from bonds and into assets that have historically generated enormous positive returns during periods of high stagflation, such as gold in the 1970s. 

Gold technical analysis: bullish RSI divergence

gold technical analysisGold technical analysis, as of September 15, 2022 – Photo: Capital.com, Source: Tradingview

For traders who place greater emphasis on technical analysis, gold prices have formed a bullish RSI divergence.

This occurs when prices hit new lows, but the indicator remains above the previous lows.

The daily relative strength index (RSI) did not fall below the 20 July low of 24; however, gold prices fell below previous lows ($1,680) to $1,663.

It might be a sign that the fierceness of the bearish movement is losing steam, which may indicate that the bottom of a downtrend has been reached.

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