Make Kitco Your Homepage

‘Where to’ for gold price? Stay cautious, says Pepperstone

Kitco News

Editor's Note: With so much market volatility, stay on top of daily news! Get caught up in minutes with our speedy summary of today's must-read news and expert opinions. Sign up here!

(Kitco News) Even after last week's selloff of nearly $100, it is too early to turn bullish on gold, according to Pepperstone head of research Chris Weston.

"The question of 'where to' for the gold market is one I've heard a lot in the past week or so," said Weston in a report on Monday. "The price action suggests staying cautious at this stage."

Weston identified three triggers that could reverse gold's downside trend — inflation scare, deflation shock, or increased use of the Federal Reserve's balance sheet.

If inflation quickly accelerates, investors will "flock to gold as a hedge," he wrote. If there is a deflation shock, gold will benefit from nominal and real bond yields dropping lower. And if the Fed signals it is ready to cap the long-end of the U.S. bond curve, gold also rises.

"Until the expected return on gold improves (as per the conditions above) and we see a far lower correlation to equities (the 30-day rolling correlation with the S&P500 is -0.35) then gold will fail to find any real trend and the opportunity cost of holding gold reduces the investment case. So, ideally, I want one of these three conditions to be met before I turn tactically bullish," Weston wrote.

And even though the sentiment in gold has turned extremely bearish, it is unlikely to reverse in the short-term.

"I don't see any of these three variables being met anytime soon. That includes the debate about the Fed capping long-end Treasuries, which is the subject of huge debate, but where I still see as a low probability," he added.

At the same time, considering February's downward move, a tactical trading rally can develop in gold, Weston admitted.

"We've seen seven consecutive weeks of outflows from the GLD ETF, where we saw $1.6b of outflows last week alone," he said. "Everything I see is that the yellow metal is oversold, and that sentiment is shot to pieces. I also see a rising risk that central banks exert themselves on the rates market this week, but until price changes direction, then I would be looking elsewhere for trades."

Investors need to pay close attention to Treasury yields, as markets seem to disagree with the Fed in terms of the timing of the potential future rate hike.

"The market disagrees and sees a real risk they raise sooner," Weston said. "A rising interest rate regime, without an inflation overshoot, is not a great stomping ground for gold."

All eyes are on Fed Chair Jerome Powell this week as he addresses the topic of the U.S. economy in a speech at the Wall Street Journal Jobs Summit on Thursday.

"There is a mismatch between the Fed's guidance on rates and market pricing, and this is where volatility arises. It's not often the market is front-running a central bank pivot, but when they see a scenario and refuse to listen to the narrative, it can be devastating – so this is a huge week for the Fed. Jay Powell's speech on 5 March is going to be huge," Weston noted.

The Fed pushing back against market expectations of a sooner-than-expected rate hike would be good news for gold, he added.

"The $1,700/$1,705 area interests, and I'll see how price reacts should it get there – however, when it comes to gold, I am a buyer of strength and not before," Weston said.

At the time of writing, April Comex gold futures were trading at $1,722.80, down 0.35% on the day.

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.