According to the 14-day Relative Strength Index (RSI), one of the most widely used technical indicator to assess market momentum, both gold and silver prices entered oversold levels in mid-May 2022, dipping below the 30 mark – a condition not seen since the two precious metals crashed in August 2021.
Gold prices have plummeted nearly 12% from their relative highs on 8 March, while silver officially has entered a bear market, with a drawdown of more than 20%.
Rising US real interest rates and a strengthening US dollar (DXY) amid a more hawkish Federal Reserve have been the key reasons weighing on gold and silver prices, with market risk aversion recently exerting further downward pressure.
A recession is a wild card for gold and silver to relieve the pressure on expectations of higher US interest rates and thereby reverse the market’s current pessimism.
But are we truly on the verge of a gold and silver bearish trend reversal, or is this merely a forewarning of even greater drops in the coming weeks?
What is your sentiment on Silver?
Why the dollar should fall to reverse gold and silver's bearish trend
Inflation in the United States remained at 40-year highs of 8.3% in April, prompting the Federal Reserve to raise interest rates by 50 basis points to 1% in May, and to signal further increases in the future, while a deteriorating global economic outlook, driven by Chinese lockdowns, pushed safe-haven demand for the greenback.
Stars have aligned for the dollar surge, but gold and silver have seen worries of increased interest rates materialise, driving the demand away.
As such, for the bearish trend in gold and silver to reverse, the dollar must lose its grip. This can only happen if market expectations about Federal Reserve interest rates hike slowdown, which usually occur when investors begin to price in a recession.
However, a US economic slump may be still too far down the road…
Gold and silver are in a bloodbath: should you buy the dip now?
Momentum on these two metals is extremely bearish, as market consensus believes the Fed will raise interest rates to contain inflation.
As a result, if the Fed continues to raise interest rates and to signal a more restrictive monetary policy, gold and silver’s current negative trend may persist.
Traders should bear in mind that precious metals are non-yielding assets that do not provide any regular interest payment, so when cash begins to give greater yields, gold and silver tend to suffer.
But what if the unexpected occurs?
The advent of two specific economic situations, which do not appear to be adequately priced by the market today, can act as a wild card for gold and silver.
The first is the Fed’s failure to manage inflation through rate increases. In this event, the dollar would continue to provide negative real returns, and investors may begin to lose faith in the currency and shift to real assets such as stocks and commodities.
The second is the sign of a Federal Reserve policy mistake, which, by excessively tightening financial conditions, would actually force the economy into a recession.
As a result, investors may consider precious metals to be an insurance against both the danger of out-of-control inflation and policy errors that lead to a recession.