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Gold’s tailwinds blowing stronger into Fed week

Commentaries & Views

After December began with an explosive move to the upside, Gold Futures are currently consolidating in a short-term consolidation triangle between the double top at $1825, down to the $1,780 floor that has been this week's range low. This also aligns to the trendline support that began with the November 3rd swing low. Yet, the silver price continues to bullishly show relative strength to gold, following a 16% gain in November.

Last week, the closely watched gold/silver ratio printed a weekly close below 80. A sustained move below this key level is needed to bring more bulls and momentum traders back into this tiny sector. Along with the silver price climbing well above the key $22 level, bullish sentiment has been building in the metal as the market continues to see record physical demand for 2022.

As gold prices pulled back to support at $1780 after a better-than-expected ISM service sector activity report for November to begin the week, weakness is being bought in the safe-haven metal while equities are showing signs of topping. With investors sensing the main threat next year being slow or negative economic growth, replacing inflation as their worst fear, a quiet flight to safety is taking place as traders attempt to front run the likely coming recession.

Meanwhile, as investor's attention shifts to the Federal Reserve's final monetary policy meeting of 2022 next week, both gold and silver's tailwinds have become stronger. The U.S. Producer Price Index (PPI) released this morning showed inflation rose 0.4% last month following October's unchanged reading, while the annual wholesale-level core inflation rate cooled to 4.9% in November.

Adding to the bullish case for the precious metals sector this week is China reporting an increase in its gold reserves for the first time in more than three years. The People's Bank of China reported that it bought 32 tonnes of gold in November to a total of 1,980 tons, the sixth-biggest central bank bullion hoard in the world. Total central bank gold holdings are at the highest level in 48 years.

There is also speculation among top strategists this week that Russia might begin selling its oil in exchange for gold. Credit Suisse's Zoltan Pozsar said in a note to clients that it is not improbable for gold to double to $3,600 an ounce if Russia responds to G7's oil price cap by accepting gold for crude.

The news came on the heels of Ghana announcing last month that its government is working on a new policy to buy oil products with gold rather than U.S. dollar reserves, Vice-President Mahamudu Bawumia said on Facebook in late November.

Bullion is now capitalizing on falling Treasury yields, and the pullback in the U.S. dollar after a parabolic 16-month move to the upside. A sharp decline in T-Bond yields, and a deepening inversion across the yield curve, suggest that recession risks have started to overshadow inflation in the eyes of investors.

Specifically, the yield on two-year notes currently yielding 4.25%, are now 71 basis points higher than the 10-year yield. This is the widest gap in the inverted yield curve in more than 40 years, raising the odds considerably of an imminent recession.

Billionaire investor and DoubleLine Capital CEO Jeffery Gundlach recently mentioned the Fed historically following the 2-year Treasury yield. The "Bond King" recently tweeted, "Fed just follows the message of the two-year Treasury yield. You can see that on a chart of the fed funds target rate and the 2-year yield. So who needs the Fed? Why not replace it with the two-year Treasury yield?"

The recent slide in yields has also dealt a blow to the U.S. dollar by eroding its interest rate advantage against other currencies, breathing new life back into gold. After being left for dead on the altar of cryptocurrencies formerly being hyped as "safe-havens," which have literally wiped-out countless millennials, the "barbarous relic" remains the ultimate safe-haven of choice with no counter-party risk.

The current macro climate resembles the ones that preceded both the 1973-74 stagflationary recession and the early 2000's tech bust, whlie creating a boom in precious metals each time. With investors sensing a likely similar macro backdrop unfolding, gold is sniffing out the fact that it is only a matter of time before the Fed's slower tightening turns into outright cuts.

Markets still see the terminal rate in the Fed Funds above 5%, while the yield on 2-year Treasuries is signaling the world's most powerful central bank may stop raising rates after next week's projected 50 basis point hike to a rate of 4.25% to 4.5%.

The recent rally in gold futures from $1620 to $1820, a whopping 11% gain since November 3, reflects a major change in market sentiment by investors. The Fed's slower rate-hike pace was confirmed by Jerome Powell last week, while the market awaits clues from the Fed next week to find out about the trend of inflation and where rates could peak.

Looking ahead, the answer to that question may come from the last U.S. inflation report scheduled to be released before the Federal Open Market Committee meets for the final time this year on December 13-14. The U.S. Consumer Price Index (CPI) data report for November will be released next Monday.

With market perception and sentiment now assuming a more dovish Fed and inflation still at an extremely high rate, this is the perfect environment for the precious metals mining complex to begin its next up-leg.

After moving up 40% from its lows seen in late October, the mining sector continues to consolidate recent out-sized gains. Once strong overhead resistance at their respective 200-day moving average resistance lines were reached last Friday, both short-term overbought GDX and GDXJ have been experiencing some healthy profit-taking this week.

With most tax-loss selling in higher-risk juniors concluding next week before the holidays, there is strong overhead resistance at $37 in GDXJ. Once momentum traders and funds come back into the sector on a GDXJ breakout above $42, quality micro and small cap juniors will begin to outperform the miners.

With the precious metals mining sector having likely created an accumulative major bottom when capitulation selling ended last month, the current weakness is presenting a lower-risk opportunity for contrarian investors.

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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.