Contributed Commentaries
Gold consolidating recent gains heading into Fed week
Kitco Commentaries | Opinions, Ideas and Markets Talk
Featuring views and opinions written by market professionals, not staff journalists.
After the gold price moved higher for two months from a $1675 double bottom at the end of Q1, bullion has been consolidating above new support at $1850 for the past few weeks. Once the safe-haven metal became short-term overbought above the $1900 region, where the metal began trading in 2021, selling has been coming in from early Q1 buyers breaking even on what had been a losing position.
Volatility ramped up near the $1,900 an ounce level just before the U.S. stock market session opened on Thursday. An hour before the market opened, investors began to digest U.S. inflation data along with earlier results of the European Central Bank (ECB) meeting that may influence the Federal Reserve's monetary policy decisions at next week's FOMC meeting.
When the ECB announced maintaining an elevated flow of stimulus as expected early morning on Thursday, the gold price sold off double-digits quickly with profit taking coming in from the shorter-term futures traders. But just a short time later, weakness was bought quickly when investors saw the consumer price index report for May come in up 0.6%, which was a bit higher than the 0.5% rise expected. Year-on-year the CPI rose to 5.0% in May versus April's rise of 4.7%.
The reading represented the biggest CPI gain since the 5.3% increase in August 2008, just before the financial crisis. And the gasoline index is up a whopping 56.2% over the past year, part of an overall 28.5% increase in energy during the period. For the year, core CPI is up 3.8%, the largest 12-month increase since the period ending June 1992, the report said.
Gold quickly turned positive on the higher-than-expected inflation news, along with the stock market. But some investors have been rotating safe-haven capital into gold since its double bottom at the end of Q1, as the Gold/SPX ratio may have struck a significant low with the gold price in March.
More importantly, gold has broken out to a 6+ year high versus bonds, as the Gold/TLT ratio has been trending higher since the March 2020 panic lows in the marketplace. With inflation now rising much faster than interest rates, real rates have now fallen to a level that is about as bullish for gold prices as anything we have seen in recent years.
During the 2-month uptrend in the gold complex, investors have been extremely sensitive to Fed-speak taper talk, the U.S. dollar, and U.S. Treasury yields. Any spike in these drivers leads to lower gold, while a reversal triggers another gold rally. The marketplace has been concerned about whether rising inflation could see the Federal Reserve taper its asset purchases, or start to talk about, talking about raising interest rates.
But the Fed has emphasized ad nauseum that recent rising price pressures are transitory, while being more focused on the employment figures that continue to disappoint. Marketplace attention now shifts towards the Fed's June 15-16 FOMC policy meeting.
Despite skyrocketing inflation figures continuing this week, the back-to-back weaker-than-consensus April and May U.S. unemployment reports are leading investors to expect the Fed to remain uber-dovish next week, as the central bank's dual mandate requires it to ensure both stable prices and maximum employment.
Furthermore, demand for a key Federal Reserve facility used to help control short-term rates surged to the highest on record this week, accommodating a barrage of cash in search of a home. The Federal Reserve's reverse repurchase (Repo) window on Thursday took in $535 billion in cash, hitting a record peak for a fourth consecutive session, while financial institutions flush with liquidity flocked to the Fed facility to park their cash and secure Treasury collateral. The U.S. Treasury has targeted a $450 billion cash balance by the end of July, the debt ceiling deadline.
Inflows should continue to overwhelm the front end this month, given the regular inflows of principal and interest payments into repo from the government sponsored enterprises, along with banks trimming back their balance sheets for regulatory purposes ahead of quarter-end.
Gennadiy Goldberg, senior U.S. interest rates strategist at TD Securities, told Bloomberg earlier this week, “The pressure will only continue to build later in the month as GSE money enters the system and quarter-end approaches." Goldberg expects volumes at the Fed's facility to rise to around $600 billion to $700 billion at the end of June and remain at the level into the Treasury's reinstatement of the debt ceiling at the end of July.
After U.S. President Biden announced a proposed $6 Trillion budget at the end of May, the Fed is selling its bonds by draining the system of cash ahead of the fiscally irresponsible government spending spree. Although the Fed jawbones rising prices being “transitory", this recent draining of cash has exceeded all levels going back to 2016 and shows the central bank is deeply concerned about inflation.
I expect the 200-day moving average in Gold Futures near $1,850 to hold on the downside heading into the next FOMC meeting next week. New money is also likely to come into the gold space once the safe-haven metal is able to successfully breach its breakeven point on the year, which is around the $1,918 an ounce level. On the upside, there is strong resistance at the $1950-$1960 region, which will require a significant catalyst to clear.
Meanwhile, the GDX has remained in its 2-month uptrend, after bouncing sharply from trendline support yesterday with rising volume. The global miner ETF has also been consolidating recent gains, having worked off its short-term overbought status and appears set to continue higher with the gold price.
But the best value remains in the junior space. The VanEck Vectors Junior Gold Miners ETF fund GDXJ holds a portfolio of mostly mid-tier and junior mining shares of companies involved in gold exploration and production. The GDXJ has begun to show relative strength to GDX since gold made a weekly close above $1850 in mid-May, even though many quality junior trains have yet to leave the station.
Being a reliable barometer for the junior resource complex, this $6 billion fund is closely followed by junior speculators and momentum traders. The index broke out of a 7-year base above $45 in mid-2020 on its way to an 180% gain in just 4.8 months, then tested this breakout level on the subsequent 33% correction by late March of this year as interest dried up in the gold complex. After testing its 7-year breakout line of support at $45 in March, the technical upside target in the GDXJ is $90.
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