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Gold trading in a tight range heading into Fed week

Commentaries & Views

With Gold Futures consolidating recent gains, renewed banking fears are keeping the safe-haven metal in a tight range around the key $2000 level as month-end book squaring takes place into Fed week. We learned this week that the recent collapse of several prominent banks in the U.S. and Europe has seen depositors withdraw a total of $508 billion dollars from banks around the world.

First Republic Bank's stock fell by about 50% Tuesday, a day after it said customers had pulled $102 billion in deposits in Q1 of 2023, well over half the $176 billion it held at the end of last year. The troubled bank has been struggling with liquidity, and its stock market value collapsed by 80% in ten trading sessions due to fears of a bank run.

The bank received a temporary $30 billion lifeline in March from the nation's biggest banks, however, those banks can withdraw their deposits as soon as July. First Republic's executives have refused to answer questions about the bank's future, as their search continues for a rescue deal.

Different problems, but fears of more bank runs are a potential risk on both sides of the Atlantic, as the health of the banking system has once again come into question. After several banking giants including First Republic, Bank of America, Barclays, Credit Suisse, Lloyds and Santander raised fresh alarm bells signaling deposit outflows have been significantly worse, herd psychology is now the big concern.

Many of the world's leading economists have been calling this recent widespread contagion; “a crisis of confidence in the banking system.” Because of this, banks and regulators must now create absolute certainty that the initial loss of confidence, which can trigger ever-increasing outflows, is prevented.

With so much capital sitting on the sidelines waiting to be deployed, traders have turned their attention to the Federal Reserve meeting next Wednesday. Markets have all but priced in a 25-basis point hike for next week. But what investors really want to hear from Fed Chair Jerome Powell are clues regarding when the Fed will be pivoting on its most aggressive interest rate hike cycle in over 40 years.

Although the market expects the Fed will raise rates one more time, by another 25 basis points to a target range of 5%-5.25%, a pause is expected later this year. And markets see a stronger than 80% chance that the central bank will lower its policy rate back to the range of 4.75%-5% by September, even if it opts for a rate hike at the upcoming meeting.

Before the Fed's blackout period began this week, committee members continued to reiterate that they "have more work to do," while Fed Funds futures are pricing in one more rate hike beyond the May meeting. Yet, the U.S. housing market showed more signs of deteriorating this week, and recent banking stresses mean lending conditions will tighten considerably.

The Fed remains steadfast in its quest to tame inflation by continuing to raise rates, even though the Conference Board Leading Economic index (LEI) is clearly signaling that a U.S. recession is already baked into the cake. The Conference Board LEI has a very good track record and is highly reliable, with it only taking seven consecutive monthly falls to signal a U.S. recession in the past. To date, the LEI is down 12-months in a row, and such readings are unheard of outside of a recession.

Over the past 70 years, a Fed pause or pivot has been followed by an economic recession 85% of the time. And immediately thereafter, gold prices began a strong up-leg to new all-time highs. Rate cuts are on the horizon, and the gold price has been sniffing out the Federal Reserve starting to loosen policy before the end of the year.

The chances of a hard landing for the economy are rising, which will mean inflation falls more quickly. The Fed's dual mandate of price stability and maximum employment gives the central bank flexibility to respond swiftly with rate cuts.

The recent action by the central bank is very similar to Fed-speak during the previous rate-hike cycle in 2018. At the Fed's last hike in 2018 on December 20th, when the S&P was -17% for the year, the central bank said it planned to hike two more times in 2019, which never happened. Instead, they cut three times that year, with the first coming in July.

The pre-mature rate cut cycle announcement pushed the gold price through 6-year resistance at $1400 in mid-2019, rising to an all-time high of $2089 by mid-2020. Good for a $700 move over the next 12 months after a Fed pivot.

Furthermore, worries over a debt ceiling showdown are creeping into U.S. options markets, as investors grow increasingly concerned that lawmakers will be unable to hammer out a deal in coming weeks. U.S. Treasury Secretary Janet Yellen on Tuesday warned that failure by Congress to raise the government's debt ceiling - and the resulting default - would trigger an "economic catastrophe" that would send interest rates higher for years to come.

Yellen told lawmakers in January the government could pay its bills only through early June without increasing the limit, which the government hit in January. The last real debt ceiling battle took place in Q3 2011, causing tumbling markets and a downgrade of U.S. debt. The delay fueled a Gold Futures blow-off rally to come within $75 of the key $2000 per ounce level.

After trading in a tight zone for the past few weeks, expect volatility in the gold price to increase on Fed decision Wednesday, followed by the European Central Bank decision on Thursday, and concluding with the release of the U.S. jobs report next Friday. On the downside, there is support at $1975, and $1950. And on the upside, Gold Futures require a monthly close above $2100 to signal a sustainable breakout technically to all-time highs.

A monthly close above the key $2000 level later today would be a significant technical achievement, and one step closer to the market beginning to price in a new floor at a level which has been strong resistance for the past 12-years.

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