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'Big buying opportunity': Gold price to rebound as U.S. faces 'lingering damage'

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(Kitco News) Gold might be down but a rebound is on its way and investors should view this setback as a buying opportunity, according to analysts. 

Gold surprised investors with a loss of $50 in the span of just two hours on Friday as markets rallied on shockingly upbeat employment news in the U.S.

The U.S. nonfarm payrolls saw a rise of 2.509 million jobs in May after seeing record losses in April. The unemployment rate came in at 13.3%. Market expectations were way off, calling for a decline of around 8 million jobs and unemployment rate of about 20% for May. 

Hope that the U.S. economy is recovering quicker than expected led to an immediate rally in the stock market. At the time of writing, the Dow was up more than 2.5% after jumping more than 700 points. Gold was sharply down with August Comex gold futures last trading at $1,686.80 an ounce, down 2.35% on the day.

“The COVID premium has probably started to be priced into the market. We had 8-10 weeks of it and it could be falling away into the background,” Rhona O’Connell, head of market analysis for EMEA and Asia regions for INTL FCStone, told Kitco News on Friday. “The employment numbers in the U.S. are going to put pressure on the gold market.” 

All of that points to more of a risk-on environment, which is why we are seeing gold come off, O’Connell added. 

But has this risk-on optimism ran ahead of itself? Some analysts warned of tough times still ahead. “While we do expect a continued surge in hiring in the coming months, the need for continued physical distancing well into the future suggests there will still be lingering damage in some industries, with the unemployment rate remaining elevated for years,” said Capital Economics senior U.S. economist Michael Pearce. 

Many analysts are also questioning just how far this equity rally can go and more importantly whether it can even last.  

“Longer term, we still got geopolitical risks as the trade tensions that not gone away. We’ve got underlying risk in the economic and financial environment,” O’Connell pointed out. “Do we know if the recovery in China and the early shoots the U.S. will cascade through to Europe? It is questionable whether the equity markets are reflecting the genuine potential for recovery in the next three-to-six months or whether they have gone too far.”

The rally in the equity space is unlikely to last, said TD Securities head of global strategy Bart Melek. 

“This equity surge is a surge only for a little while. At some point, there may be a correction,” Melek said. “The reality is that we will still have massive unemployment, economy will be massively under potential and that means central banks and governments will have to continue to add stimulus. I suspect that central banks will allow inflation to move above 2%. At the same time, we are producing massive amount of debt.”

The U.S. economic recovery will not be smooth and quick. “There will be some structural issues … The first phase of the recovery is the easy stuff,” Melek added.

Good news for gold?

Melek sees gold rebounding from its Friday lows next week, noting that he views these major dips as important buying opportunities. 

“There is strong support around $1,660-70,” he told Kitco News. “We’ve always argued that for now we are going to be in the lower bound. To me, these are big buying opportunities because as we move on and things stabilize, we are not going to get these big employment surprises. It is going to be very tough to get to full potential. And that implies continued stimulus.” 

O’Connell sees gold beginning to consolidate around the current levels. 

Friday’s drop could end up being good for prices, said Gainesville Coins precious metals expert Everett Millman.

“Next week is set up for a nice rebound in gold since we lost a lot of key support levels this week,” Millman said. “There is more room to run higher now. All the fundamentals that have been supporting gold are not gone yet. One of the big factors I’ll be looking for is the second wave that everyone is fearful of right now. That could be supportive of higher gold prices if a lot of countries will have to shut down economies again.”

On the downside, Millman is looking at $1,650 and on the upside he views a move back above $1,700 an ounce as “a bullish sign.” 

Another important side of the issue here is that quick economic recovery might end up working in favor of higher gold prices in the long-term by creating inflationary pressures. 

“The central banks can’t put that genie [massive stimulus] back into the bottle. And if major economies recover so quickly, combined with all the cash pumped into the financial system, how can such not be inflationary, and even cause problematic inflation? That’s a very bullish scenario for commodity markets, including the metals,” Kitco’s senior market analyst Jim Wyckoff pointed out on Friday. 

Once inflation kicks in, Melek sees gold reaching $2,000 an ounce. He estimates that goal to be reached late next year. “That is when inflation should start materializing. We are going to see most likely the U.S. dollar weaken,” he noted. 

Fed meeting on the radar

The Federal Reserve rate announcement is scheduled for Wednesday, followed by the Fed Chair Jerome Powell’s press conference. No surprises are expected as the central bank is projected to keep rates unchanged near the zero bound. 

“The Fed is already at zero bound. They will most likely tell us that we are still below potential and the Fed will continue to add to the balance sheet and support the economy in any way it needs to. The Fed is going to be there to support both fiscal spending and support credit. There shouldn’t be any big surprises here,” Melek pointed out. 

The Fed has worked hard to telegraph its decision to avoid any market surprises, Millman added. “There is a good argument to be made that the Fed announcement is priced in,” he said.

Key data to watch

Other important datasets to watch next week include Wednesday’s CPI (Consumer Price Index) release for May, Thursday’s jobless claims and the PPI report for May. 

“Data-wise, consumer price inflation should continue to ease given the lack of demand in the economy. The food component is likely to see further price pressures though given the dramatic switching away from food services towards grocery and the strains this has placed on supply chains,” ING chief international economist James Knightley said. 

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