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Gold's Push Past $1,300 Has Legs As U.S. Threatens Mexico With Tariffs

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(Kitco News) - After a slow start to the week, the gold market is finally living up to its potential as a safe-haven asset as prices push back above $1,300 an ounce ahead of the weekend.

Gold’s attractiveness lies in that it is considered one of the cheapest safe-haven assets within financial markets. Although the U.S. dollar index has been unable to hold gains above 98 points, it is still trading near a two-year high. At the same time, U.S. 10-year bond yields are trading at their lowest level in 21 months at 2.16%. Gold, on the other hand, is trading at a two-week high. August gold futures last traded at $1,309.20 an ounce, up more than 1% since last week.

“There is no doubt that gold will continue to look attractive as the U.S. dollar falls and with bond yields at current levels,” said Christopher Vecchio, senior currency strategist, at DailyFX.com.

According to some analysts, geopolitical tensions have reached a tipping point after U.S. President Donald Trump threatened to implement 5% tariffs on Mexico in his latest attempt to curve illegal immigration into the U.S.

The President’s tough tariff talk comes after China threatened to reduce exports of its rare earth metals, which would severely cripple the global supply chain for many international companies.

Ross Strachan, senior commodities economist at Capital Economics, said that either scenario on its own would not have had much of an impact on the gold market, but together they continue to highlight growing geopolitical uncertainty and raises the threat of a significant global economic slowdown or even an outright recession.

“We are seeing a drip-feed of events finally impacting gold’s safe-haven appeal,” he said. “We’ve been expecting gold to perform well in this environment and it is living up to our expectations.”

Mexican Tariffs Will Impact More Than Just Avocado Prices

Economists have noted that Trump’s tariff threats against Mexico could have a more significant impact than his trade war with China. Mexico is the U.S.’s third largest trading partner and because of the North American Free Trade Agreement, the supply chain between the U.S. Mexico and Canada is highly integrated.

“In some industries, a good can cross the borders many times before it is a finished good.  That means a product could be hit with the tariff several times,” said Marc Chandler, chief market strategist at Bannockburn Global Forex. “And when we say that production is organized across the continent, it is understood that it did not simply become this way, large companies, mostly American, but also many European and Japanese businesses have integrated the continent.”

According to government stats, the U.S. exported $265 billion in goods to Mexico last year, more than to China, Japan and Germany combined. At the same time, the country imported $347 billion in goods from Mexico.

Colin Cieszynski, Chief Market Strategist, at SIA Wealth Management, said that he is bullish on gold in an environment where geopolitical uncertainty has become unhinged.

“Trump’s threat has thrown some serious sand into the gears of the entire North American economy,” he said. “A few weeks ago we thought the new free trade agreement was settled and then the President blows it up with one tweet. The latest tariff news shows that nothing with this government is settled and that underscores the uncertainty in financial markets. The gold market will do well in this uncertain environment.”

Recession Fears Continue To Grow

The rising global trade tensions have created palpable fear in the marketplace as investors now worry about the growing risks of a recession.

Many analysts have noted a further inversion of several yield curves as a sign of the growing risks of a recession. According to reports, the 3-month/10-year yield curve is the most inverted since 2007.

In a note published earlier in the year, Steen Jakobsen, chief economist at Saxo Bank, said that they see the Federal Reserve cutting interest rates by 50 basis points by October.

Jakobsen’s call isn’t far from market consensus with markets pricing in an 88% chance of one rate cut and a nearly 60% chance of two rate cuts by the end of the year.

In a weekly research note, economists at BNP Paribas note that in a recent survey, 84% of chief financial officers expect that the U.S. will enter a recession by the first quarter of 2021.

“This very high percentage is a matter of concern, considering that empirical research in the U.S. shows that CFO earnings expectations for the next 12 months are highly correlated with planned and actual corporate investments,” the analysts said. “When many CFOs expect a recession, one would assume this will be reflected in lower earnings forecasts and cutbacks in capital expenditures. This could even lead to self-realizing bearish expectations: recession fears end up causing a recession.”

Is This Rally Sustainable?

Although there is growing optimism in the gold marketplace, some investors are still a little gun shy to jump entirely into the marketplace. The market has seen a $1,300 handle before, only to fall to a one-month low shortly after.

Bill Baruch said that he is optimistic that this time will be different as sentiment within financial markets is shifting.

“This is a constructive landscape for gold and as long as the U.S. dollar struggles to make new highs and bond yields remain at current levels, we will continue to see higher gold prices,” said Bill Baruch, President of Blue Line Futures.

However, he added that he doesn’t recommend that investors chase the market at these levels.

To confirm the breakout, he added that he would like to see silver prices move higher.

“I think silver needs to join the party to bring some staying power to the precious metals,” he said.

Strachan said that he is also positive on gold and expects that further weakness in equity markets will continue to drive gold prices higher.

Cieszynski said that a weekly close above $1,303 an ounce help to instill some confidence in the marketplace, but he added that he would like to see some follow-through buying that would push prices above $1,310.

Vecchio said that he is encouraged that this rally in gold is sustainable as volatility in the precious metals market is starting to rise.

“Volatility has been rising throughout financial markets expect in gold. Earlier this week the GVZ hit its all-time lowest level. Unlike other markets, gold does well when volatility picks up,” Vecchio.

Vecchio said that although inflation is stabilizing at lower levels, the fact that bond yields have dropped sharply means that real rates have fallen, which is positive for gold, a nonyielding asset.

The Final Say

Although investors will be focused on the ongoing geopolitical turmoil, they will also need to pay attention to a raft of important economic data.

The economic docket starts next week with the release of the Institute for Supply management’s sentiment survey for the manufacturing sector and then ends with the release of U.S. employment data for May.

Markets will also be paying close attention to the European Central Bank’s monetary policy meeting.

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