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Gold faces a difficult second half but it’s not hopeless - World Gold Council

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(Kitco News) - Gold's neutral price action in the first half of the year made it one of the best-performing assets in financial markets. While there is still strong support for the precious metal, the World Gold Council warned investors that gold faces some complex challenges in the second half of the year.

Gold is already off to a rough start after dropping 4% and testing long-term support at $1,730 an ounce at the start of the week. The precious metal has attracted some bargain hunting but remains below critical psychological levels. August gold futures last traded at $1,744.10 an ounce, up 0.44% on the day.

In its latest report, the WGC said that gold remains caught in a tug of war between aggressive central bank tightening and rising inflation pressures, equity market volatility and geopolitical uncertainty.

So far, investors are reacting more to the Federal Reserve's commitment to aggressively raise interest rates to cool down inflation; however, analysts at the WGC said there are still reasons for gold investors to remain optimistic that the market can withstand these headwinds.

"While most market participants still expect significant policy rate increases, some analysts argue that central banks may not tighten monetary policy as much as expected. Their reasons include potential economic slowdowns that may result in contractions, but also in some cases a switch from supply constraints to supply surpluses in non-commodity consumer sectors," the analysts said.

At the same time, although interest rates and real rates are rising, the WGC noted that persistently high inflation will ultimately cap any major push higher.

"Gold has historically performed well amid high inflation. In years when inflation was higher than 3%, gold's price increased 14% on average, and in periods where US CPI averaged over 5% on a y-o-y basis – currently at ~8% – gold has averaged nearly 25%," the analysts said.

U.S. Mint gold bullion sales drop 76% in June year-over-year; silver bullion demand down 69%

The report also said that despite higher real rates, gold's opportunity costs remain attractive compared to other assets. The analysts pointed out that as market volatility rises, investors have few choices to protect their capital. The analysts said inflation-linked bonds have declined 18% so far this year.

"High-quality government bonds have been a favored safe-haven asset over the last 20 years because of low inflation and interest rates. But higher inflation weakens the appeal of government bonds as a diversifier," the analysts said.

28 tonnes of gold flows out of global ETFs

The relatively optimistic outlook for gold in the second half comes as global gold-backed exchange-traded products saw their second month of outflows in June.

In a separate report published Thursday, the WGC said that 28.5 tonnes of gold were liquated from ETFs last month, following 53 tonnes of outflows in May.

"While the recent flows were enough to push Q2 into net outflows of 39t, year-to-date net inflows remained positive at 234t. Total holdings at the end of June stood at 3,792t," the analysts said.

The dominating factor for the gold market remains rising interest rates worldwide, led by the Federal Reserve, which raised interest rates by 75 basis points last month. Markets are looking for another 75-basis point move in July.

"Intense focus on the future pace of interest rate hikes and a stronger U.S. dollar were the primary headwinds for gold investment," the analysts said. "Despite the gloomy economic outlook for Europe, with record inflation and rising sovereign borrowing costs, the European Central Bank indicated it will raise interest rates in July – the first hike in more than 11 years – which weighed on sentiment."

Looking at regional flows, American listed gold-backed ETFs saw 26 tonnes of gold flee the market. At the same time, European firms saw outflows of 4 tonnes.

Bucking the global trend, Asian-based ETFs saw inflows of 1.1 tonnes.

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