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Gold volatility increases as war adds to ongoing inflationary fears

Commentaries & Views

The gold price rallied sharply on Wednesday evening as Russia initiated a full-blown military action in Ukraine. With financial markets entering panic mode, after the news of a war that Western politicians had incessantly warned being imminent, the safe-haven metal zoomed to the $1975 region into the early Thursday morning Comex trade.

But as gold priced in the Russian actions that most everyone was expecting, along with becoming extreme overbought on a short-term basis, bullion whipsawed to reverse nearly $100 lower by Thursday afternoon to test the $1880 support zone before stabilizing. A recovery on Wall Street became the catalyst to push gold back below the important $1,900 level briefly, where the safe-haven metal had been consolidating since last Friday.

Stocks reversed Thursday’s sharp earlier declines after U.S. President Biden placed several aggressive international sanctions against Russian banks and state-owned companies. Yet, after the gold dust settled yesterday, its price had closed back above the key $1900 per ounce level by the end of Comex trade.

However, precious metals investors should brace for more volatility ahead as Russia's military action in Ukraine continues, along with ongoing inflationary concerns as the Federal Reserve gears up to begin a long overdue rate-hike cycle.

With the Fed being so far behind the inflation curve regardless of what happens in Ukraine, Fed officials on Thursday were unanimous in their agreement of inflation being too high and that interest rates should be increased at the upcoming FOMC meeting in March.

This morning, the U.S. Department of Commerce said the core PCE price index jumped 5.2%, up from last month’s reading at 4.9%. Overall, the report said that headline PCE inflation rose 0.6% in January, up from December’s reading of 0.5%. For the year inflation increased 6.1%, up from December’ annual increase of 5.9%. The report noted that energy prices increased a staggering 25.9% while food prices increased 6.7%.

Although Russian military action in Ukraine has made the Fed’s monetary policy much more uncertain, between 150-175 bp of rate-hike tightening over the next 12 months remains priced in. But an initial 50 bp hike is now less likely.

It remains to be seen if the current situation in Ukraine causes the Fed to be less aggressive in raising rates. But even if it does, rising energy prices around the globe suggest that inflationary pressures will continue to rise, which will make the Fed's job even more difficult once the tightening process is expected to begin in just a few weeks.  

Inflation is currently raging at levels not seen since the early 1980’s, however, there is a massive difference between then and now. I am old enough to remember the stagflation of the 1970’s, which lasted for most of that decade and propelled the gold price from $100 in 1975, to $850 by January of 1980. It was a great time to be invested in commodities that rose sharply along with interest rates, but not good for stocks and bonds.

The Fed was able to hike rates to an incredible 20% in the late 1970’s to eventually put the inflation genie back in the bottle by the late 1980’s. Whereas the Fed could hike rates substantially in the 1970’s, it cannot do so this time because of the unprecedented debt. The $30 trillion national debt, of which 70% is accumulative interest payments, is at 125% of GDP now. By the time Federal Reserve Chairman Paul Volcker raised the Fed Funds Rate to 20% in January of 1980, the U.S. national debt was $900 billion at only 34% of GDP.

The world’s largest central bank rising rates beyond just 150-175 bp this time around may risk a serious policy error, putting added pressure on an already weak stock market as well as the economy, which is the definition of stagflation.

After gold's sharp doubling in price from 2016 to 2020, the safe-haven metal has been in a prolonged pullback/consolidation phase to digest those out-sized gains. Gold's peak to trough correction ($2,089-$1,673) was 20%, a textbook correction down to its .382 Fibonacci retracement level, which has been tested three separate times.

Since the last test of $1675 in August of 2021, we have seen a series of higher lows and higher highs with crucial overhead resistance at the $1,900 region. In last week’s missive, I noted that we will need to see a monthly close above $1900 for technical confirmation of a bullish breakout of gold’s 18-month consolidation.

After gold volatility increased considerably mid-week, there remains some support at the $1880 level, with stronger support at the $1850 region being where the war premium began to be priced in. With volatility increasing, if the gold price continues to ride its sharply rising upper daily Bollinger Band higher into month-end next Monday, a solid close above $1900 would technically confirm a major gold bottom being in place.

Looking at the bigger picture, gold has created a significant 12-year cup and handle pattern, which would be completed once the $2100 level has been breached on a monthly closing basis. There are not too many examples of a multi-year cup and handle pattern in the major markets, and investors should understand how bullish this pattern can be when it occurs over a long period of time. The current cup and handle pattern in gold projects to a technically measured upside target of around $3,000.

Meanwhile, the precious metals mining complex continues to construct an accumulative bottom below the crucial resistance levels of $35 in GDX, and $47 in GDXJ. Historically, the start of Federal Reserve rate-hike cycles has marked significant bottoms in the gold price in 1999, 2004, and 2015.

Similar to the current situation in the gold complex, during the lead-in to a telegraphed rate-hike cycle by the Fed in late 2015, mining stocks began to bottom six months prior to the announced hike in mid-December. And once the tightening process began, the mining sector nearly tripled in just six months from a similarly depressed level and accumulation time-frame which has recently been taking place.

If past is prologue, six months from the low struck in GDX at the $28 level on the last day of September would take us into the first week of March. Once we see a weekly close above strong resistance at $35 in the global miner ETF, the odds would increase significantly of the mining sector having completed a major accumulative bottom.

Once we see a weekly close above $47 in the GDXJ with good volume as well, the odds increase substantially of a significant bottom being in place in the junior space. I also expect quality higher-risk juniors to begin outperforming the mining space once this level has been breached.

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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.