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Debt can kick moves gold towards the key $2000 level

Commentaries & Views

After a healthy 7% gold price correction of a $465 move higher since the November low at $1620, bullion is already knocking on the $2000 door again. The sharp move higher in the safe-haven metal this week has been fueled by a debt ceiling deal, along with several Fed governors hinting of a rate hike pause during the upcoming FOMC policy meeting later this month putting pressure on the U.S. dollar.

To begin the week, Gold Futures sold down below support at the $1950 region overseas while the COMEX was closed for the U.S. Memorial Day holiday. But since coming within $4 of the all-time high at$2089 in early May, June Futures ended the month down just $17 by the COMEX close on Wednesday.

With recent drama over the raising of the debt ceiling coming to a head, the U.S. House of Representatives passed a bill on Wednesday to temporarily suspend the debt limit through December 31, 2024. This came after President Joe Biden and Republican House Speaker Kevin McCarthy agreed to cap some federal spending in order to prevent a default.

With just days to spare before the deadline for the nation to face financial default, the Senate approved compromise, bipartisan legislation to lift the debt ceiling. The bill cleared the chamber by a bipartisan 63-36 vote. Senate Majority Leader Chuck Schumer celebrated an agreement by senators late Thursday to speed up consideration to send the bill to President Biden's desk.

The deal suspends the $31.4 trillion debt ceiling until Jan. 1, 2025, meaning Congress would not need to address the issue again until after the November 2024 presidential election. In an unusual step during the votes, Schumer and House Minority Leader Mitch McConnell of Kentucky released a joint statement noting that the legislation cannot block future emergency supplemental funding, such as additional aid to Ukraine.

When World War I dragged on longer than expected, the U.S. debt ceiling was created in 1917 to finance war and it has never been reduced. With nobody in Washington ever being interested in actually paying off the national debt, this "ceiling” has been raised over 90 times.

The last time the debt ceiling became a political football was in 2011, with Democrat president Obama and a Republican-led Congress. Just two days before it was thought that U.S. borrowing authority might be exhausted, the ceiling was raised on July 31, 2011. The end-result of a publicly ugly debt ceiling debate was the U.S. credit rating being downgraded by S&P from AAA to AA+ the following week.

The on-going debt ceiling debacle, coupled with an S&P credit downgrade, sparked a sharp sell-off in the stock market into safe-haven gold. The S&P 500 sold off nearly 20%, while the gold price eventually topped out at all-time highs by September 2011, with a gain of 18% from the July 31 raising of the debt ceiling.

There were more debt ceiling battles in 2013, 2014, and 2015, all resulting in suspensions and temporary measures that allowed things to continue with no subsequent credit downgrades. During President Biden's first half term, a Democrat-controlled Congress and Senate allowed the debt ceiling to be raised to its current level of $31.4 trillion with little fanfare.

Congress being totally unable, or unwilling, to take the necessary steps to preclude the parties from having to negotiate under threat of mutual economic destruction yet again has negatively impacted the U.S. reputation. Some 70% of the U.S. budget is devoted to Social Security, Medicare/Medicaid, defense, and interest on the debt, while debt/GDP is over 120%. At the turn of the century, it was 59%.

Yet another debt ceiling can kick, with "future emergency supplemental funding,” could also negatively impact the U.S. dollar as the world's reserve currency. In fact, after the U.S. removed Russia from the SWIFT payment system last year, eastern central banks with foreign policy conflicts or disagreements with the U.S. have become less likely to use the dollar as a reserve asset.

Moreover, since the outbreak of hostilities in Ukraine and the freezing of Russia's forex reserves, foreign central banks' purchases of gold using U.S. dollar reserves have accelerated. On Monday, the World Gold Council reported central banks remain very keen on boosting their gold reserves, with 24% saying they plan to buy more precious metal in the next 12 months.

There was also a dramatic shift in expectations this week for the Federal Reserve's upcoming meeting on June 13-14. Philadelphia Federal Reserve President Patrick Harker on Thursday said: "It's time to hit the stop button for one meeting and see how it goes.”

On Wednesday, Fed governor Philip Jefferson also talked up the idea of holding rates steady later this month. Chairman Jerome Powell made it clear at the last Fed meeting that policy makers will be data dependent in future rate decisions.

The dovish remarks came after Deutsche Bank's annual default study early Wednesday showed a wave of debt defaults being imminent in the U.S. and Europe. Aggressive interest rate hikes by major central banks, including the U.S. Federal Reserve, have increased the risks of a global recession. Germany, the largest economy in Europe, has already entered a recession.

The month of June began with the U.S. Dollar Index having its biggest one-day tumble since March 10, falling 0.7% and pushing Gold Futures up to test the $2000 level. The DXY drop came after an industry report showed layoffs in the U.S. tech, retail, and auto sectors surged last month and overall hirings came in at the lowest since 2016.

As I type this column, Gold Futures remain in striking distance of the important $2000 level after U.S. nonfarm payrolls rose by 339,000 last month, according to the Bureau of Labor Statistics on Friday morning. The monthly figure was significantly above the market consensus estimate of 193,000.

However, looking past the headline jobs number, the report stated the U.S. unemployment rate rose sharply to 3.7%, missing market consensus calls of 3.5% for May. The CME FedWatch Tool is predicting a 70% probability that the Fed will begin to pause hikes as early as this month.

Meanwhile, deeply undervalued gold stocks are bouncing from key support levels this week. After becoming short-term extreme oversold, both GDX and GDXJ are in the process of rising from strong support at $30 and $35, respectively.

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