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Gold price rally in May? Chances are tied to inflation expectations as U.S. data runs hot – analysts

Kitco News

(Kitco News) Next week's U.S. data will be running hot, and gold will be closely following the market's inflation expectations as commodities continue to surge, analysts told Kitco News.

For now, the gold market is ignoring its perfect storm of low interest rates, more government spending, and rising inflation expectations. However, next week could test the Federal Reserve's policy stance that it is too early to start tapering.

All eyes will be on the slate of what looks to be very strong macroeconomic data, including manufacturing and employment reports.

"Gold is well-positioned to break above the $1,800 level. We are still maintaining our $1,900 target for this year," TD Securities head of global strategy Bart Melek told Kitco News.

In Q2, the U.S. will see significantly better-than-expected economic data.

"In terms of next week, the ISM manufacturing is very important to look at. Payroll numbers are quite important. Generally speaking, any surprise to the upside will get inflation expectations higher. That could drive real rates lower, which would be a good catalyst for gold," Melek said. "Normally, it works the other way around. But markets are starting to believe that the Fed is committed to running the economy hot. And as inflation moves higher, it is unlikely that we'll see a big pick up in yields, which is good for gold."

The ISM manufacturing PMI is due out on Monday, and the April jobs report is scheduled for Friday. Other key macro data next week include factory orders on Tuesday, ADP nonfarm employment and ISM non-manufacturing PMI on Wednesday, as well as jobless claims on Thursday.

Better-than-expected data is likely to put pressure on the Federal Reserve, which said this week that it was too early to start rolling back its monthly asset purchases.

"We suspect the Federal Reserve will be forced into an earlier policy tightening than the 2024 date for the first interest rate hike they are currently signaling, particularly with another $4tn of fiscal support set to hit the economy in addition to the $5tn already spent to support the economy through the pandemic," said ING chief international economist James Knightley.

Why does gold fail at $1,800?

The psychologically important $1,800 level seems unreachable for gold for the time being despite all the positive drivers surrounding the precious metal at the moment.

"With everything going on, gold should be taking off, and it is not. Everything is bullish for gold. Commodities are exploding right now. U.S. construction is booming. Inflation is really going to come, especially with the new infrastructure bill," said Phoenix Futures and Options LLC president Kevin Grady.

Plus, once the government starts getting involved with construction bids across the U.S., commodities will surge even higher, Grady noted, explaining that the U.S. government is not a discount buyer.

"There is inflation, and that is why gold should be going higher. However, problems will come when the government finally realizes that it can't control inflation after letting it run above 2%. But if gold is not rallying in an environment where we see inflation, what will happen when they raise rates?"

Grady blamed the popularity of cryptocurrencies for gold not rallying more, stating that bitcoin has been taking investors' attention away from gold.

From a technical perspective, the $1,800 level is 5% down since the start of the year, Walsh Trading co-director Sean Lusk told Kitco News.

"You have sellers emerging at those levels. Until you get a rally over $1,800, gold will trade sideways," Lusk said. "All the rage in the market continues to be cryptos even though we've seen some outflows."

Before gold can move above $1,800 on a sustained basis, the market will need to be convinced that the U.S. will see sustained inflation, not just transitory. Plus, other parts of the world should begin to recover, Melek said. "This would mean a permanently weaker U.S. dollar."

The rallying stock market amid a strong earnings season is also holding back gold, Melek added. "Even though yields have been negative, equity markets have performed very well. There is a reluctance from investors to position themselves in non-yielding assets. However, momentum in equities should slow down a bit, which will help gold," he said.

Lusk also noted that the new record highs in equity markets are capping gold's gains. "Continued inflows into the stock market amid the 10-year Treasury yields creeping higher hasn't spurred a lot of investment into metals," he explained.

Levels to watch next week

The 100-day moving average at $1,799 is a bit like a brick wall, Melek said. "That is a fairly large technical level. If we go through that 100-day, I wouldn't be surprised if we trade around $1,810."

Gold has a chance to finally tackle the $1,800 next time it approaches the mark, Lusk said. If gold succeeds, the metal could be looking at $1,895, which is the unchanged level since the beginning of the year.

However, a close below $1,734 would be disastrous and could push gold back down to $1,677, he added.

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