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Gold at 14-Month High Heading into FOMC Meeting Next Week

Commentaries & Views

Gold prices are trading at overhead resistance this morning as mounting concerns about the health of China's economy have hit riskier commodities and tensions in the Middle East are pushing investors into safe-haven assets.

The move began to accelerate earlier this week when the closely watched CPI Report, which measures U.S. inflation, was released on Wednesday. The core consumer price index, which removes energy and food costs, rose 2% from a year earlier and trailed forecasts in May.

Monthly core price-rises, as well as a wider measure of annual inflation, came in below estimates, along with the broader CPI increasing an annual 1.8%, which was less than projected. August Gold continued to rise towards key technical resistance at $1350 on Thursday, supported by expectations of an interest rate cut by the U.S. Federal Reserve following the soft inflation data, along with news of another attack on big ships in the Persian Gulf region.

After the soft U.S. inflation data was released, the Fed Funds Futures projection of a rate cut by the central bank at its July 31st meeting rose to 87%, with a more than 25% chance of a cut next week. The last Fed rate cut cycle began in August 2007, which sparked a gold rally of 32% into 2008.

These recent developments have gold in the process of testing the long-term resistance line in the $1350-$1375 region once again. The safe-haven metal has a few intermarket trends working in its favor and one of them is the possibility of the U.S. dollar running out of reasons to move higher.

More often than not, gold and the dollar trend in opposite directions and the world’s reserve currency appears to have peaked at the start of 2017. The possible reversal of Fed policy has been the catalyst for the dollar beginning to break down from a bearish ending diagonal pattern late last month. A weaker greenback has been historically good for bullion and could increase the odds for higher gold prices. 

Since gold is a non-yielding asset, falling interest rates are also supporting bullion. As a result, gold loses favor when interest rates are rising but becomes more attractive when rates are falling, like they are now. In fact, the ten-year treasury yield began to weaken as the gold price made its low at $1167 last September.

This week, ten-year treasury yields have pushed down to 2.13% while short term rates, like the three-month treasury, have held steady at 2.38%. This inverted yield curve has predicted the last four recessions and generally we see a recession occur within 7 to 24 months after this gold bullish phenomenon has lasted for more than a quarter. A sharp downturn in bond yields during 2007 coincided with a big upturn in gold.

Falling bond yields between 2007 and 2012 supported a strong gold market. The upturn in yields during 2012 and 2013, however, coincided with a big drop in the safe haven metal and was largely responsible for kicking off the bear market we have been mired in ever since.

This year's downturn in yields is providing another boost to gold and pushing it closer to an upside breakout of its nearly six-year basing pattern. One of the factors pulling bond yields lower is the growing expectation of the aforementioned reversal in Fed policy by announcing the beginning of a rate cut cycle very soon. This could weaken the dollar even further, which would also be good for gold.

Moreover, investors favor gold when they start to lose confidence in stocks and lose interest in gold when stocks are strong. The safe-haven metal began a secular bull market after stocks peaked in 2000 and continued to outperform stocks during the “lost decade” between 2000 and 2010.  Although gold did especially well during 2007 and 2008 heading into the stock meltdown, the entire complex was sold as investors sold anything with a bid to build cash during the crisis. 

However, precious metals began to bottom a few months before the stock market and peaked during 2011, which was two years after stocks turned up in 2009. The big drop in gold during 2013 coincided with stocks hitting all-time highs and equities have outperformed gold since then.   

Historically, gold has performed better when stocks have weakened, which was especially true last October when a sharp downturn in stocks coincided with a jump in gold. This week's stock rebound has caused gold to pull back a little. But it seems clear that the ultimate direction of gold prices will depend to a large extent on what the stock market does from here, along with the direction of interest rates and the dollar.

As we head into the FOMC meeting next week, it appears the market is expecting the Fed to begin priming the market for its first rate cut cycle in nearly 12 years, due to the on-going trade war with China and a weakening economy. The speech by Federal Reserve chairman Jerome Powell after the conclusion of the 2-day meeting will be given at 2pm EST on June 19th, followed by a press conference at 2:30pm.

With the previously mentioned gold friendly developments, it would not take much to push the metal through overhead resistance and a decisive close over $1362 this month would constitute a major upside breakout for the yellow metal.

Furthermore, the GDX is beginning to rise faster than gold, which is usually a positive sign for both. The global miner ETF bounced off its 200-day average during May and has risen above its 50-day line since then and is poised to attack long-term resistance at $25. Historically, gold miners rise faster than the commodity in a gold uptrend and they have outpaced the safe-haven metal on a relative basis since last September.  

Historically, once the sector has made a significant bottom, global miners and royalty firms are the first to move higher, followed by mid-tier producers and then the higher risk juniors. If you require assistance in choosing the best quality juniors to invest, please stop by my website and check out the subscription service at http://juniorminerjunky.com/

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.

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