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As gold price eyes $2,000 again, its 'big test' is yet to come, says MKS PAMP

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(Kitco News) Hotter-than-expected inflation data kept gold in demand as prices breached the $1,980 an ounce level. But, the precious metal's "big test" is yet to come, according to MKS PAMP.

Markets are digesting inflation accelerating to new four-decade highs in March after rising 8.5% from a year earlier. On top of that, the U.S. Producer Price Index (PPI) advanced 11.2% from a year ago in March, posting another new record.

Many economists are projecting for March figures to mark a peak in inflation, citing decelerating core inflation, base effects, and some easing in supply chain issues.

Yet the gold market is still rising, unafraid of an aggressive Federal Reserve. June Comex gold futures advanced to $1,981.00 Wednesday, up 0.25% on the day.

"If this really is 'peak inflation' coupled with impending back-to-back 50bp Fed hikes, gold should be trading very defensively… it is not. Prices are up $30 since the CPI print as it harnesses the oversimplified view that 'high inflation prints = higher gold' program instead of the 'high inflation = hawkish Fed = lower gold' one," said MKS PAMP head of metals strategy Nicky Shiels.

The problem is that even if inflation is decelerating, it is still running at more than 8% from a year ago. "The reversal in (inflation growth) trend is a welcomed sign economically, but sometimes the market loses sight of aggregate levels; pace & direction matter, but so do base levels," said Shiels.

Base levels do matter as they put everything into perspective, the metals strategist added, pointing out that even the Federal Reserve's upcoming qualitative easing (QT) is being kicked off only after the central bank's balance sheet was allowed to expand to $9 trillion.

"Liquidity is being withdrawn, [but] it's off an egregious base – the $9tn Fed Balance sheet – which perhaps explains why there has not been any expected taper tantrum in risk markets," she said. "[Same with] rising real yields … the base remains still negative and very low on a historical level. [This] explains why gold has ignored higher rates and keeps probing upsides."

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The gold market sees this and looks past two oversized 50-basis-point rate hikes the markets are pricing in at the May and June FOMC meetings.

"Six months ago, if the market had known gold was staring down back-to-back 50bp hikes, no-one would 1) expect gold to be above $1900/oz and 2) gold to be holding, trading offensively, refuting any $50+ drawdowns," Shiels added. "The question should be, is 50bp enough? Gold argues it isn't. Once gold prices start responding – lower — to the threat of 75/100/200bp Fed hikes, that's a sign that the market believes interest rate policies have a handle on inflation."

According to Shiels, a chance of even a more aggressive tightening path is why gold's "big test is yet to come," according to Shiels. Right now, the gold price is being driven by geopolitics and inflation. But the metal's resilience against the expected market volatility is what will matter most in this year's price action.

Shiels explained: "Real fed funds rate indicates the market hasn't even begun sizeable tightening. It explains why U.S. stocks are holding up but once sizeable tightening/QT does begin, gold… will be tested. The idea that the 'QE [quantitative easing] winners' post-2008 and more recently post-2020 (which were crypto/equities/tech/meme stocks etc, NOT gold) will be the larger 'QT losers' is convincing. This is the big 'test' for gold – does it obey 'symmetry' and not unwind as much as the QE winners (like stocks/crypto/tech) on QT since it really didn't outperform those assets on the way up?"

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