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This is why gold is below $1,800 even as U.S. inflation hits a 40-year high at 9.1%

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(Kitco News) - The gold market has bounced off its low but is still struggling to find solid bullish momentum after U.S. inflation rose 9.1% in June.

Some gold investors have been frustrated with gold's recent price action as the precious metal is traditionally seen as an inflation hedge. As markets digest the latest Consumer Price Index report, gold is starting to see some solid gains. August gold futures last traded at $1,738.30 an ounce, up 0.72% on the day.

However, some analysts note that gold's relatively disappointing price action makes sense within a broader market scope.

Despite gold's rally, analysts note that the precious metal is generally struggling as an inflation hedge because markets don't see inflation as a long-term threat as the Federal Reserve aggressively raises interest rates. Following the June Consumer Price Index report, markets are now pricing in a more than 50% chance that the U.S. central bank will move by a full 1.00%. For comparison, markets were only pricing in less than 8% chance Tuesday.

“While in theory gold prices should benefit from higher inflation numbers, the reality is that these higher inflation figures suggest that the Fed is likely to become even more aggressive in rasing rates to quell strong inflation. This is resulting in a stronger U.S. dollar versus other major currencies as well as placing a lid on future inflation expectations,” said commodity analysts at CPM Group in a note to clients.

Although inflation is rising, the Federal Reserve's resolve to bring it down is pushing real yields higher, causing breakeven rates to fall. Breakeven rates, the difference between nominal and real yields, have fallen across the curve at the fastest pace in two years.

In a recent interview with Kitco News, Ole Hansen, head of commodity strategy at Saxo Bank, said noted the discrepancy between inflation and the one-year/one-year breakeven rate of below 4%. At the same time, the five-year/five-year breakeven rate is hovering around 2.6%.

"We got a 5% discrepancy between where inflation is expected to be in the years'time and where it is right now. Are we going to see inflation drop 5%? I sincerely doubt it. But for now, the market is betting on the Fed's ability to hike rates and for growth to come down, taking inflation with it," he said.

Katherine Judge, senior economist at CIBC, said that she expects inflation pressures to continue to ease as the Federal Reserve aggressively tightens interest rates.

"Our forecast to get the ceiling for the fed funds rate up to 3.25% this year, combined with higher prices dampening consumer demand in discretionary areas of the economy, should produce enough of a growth slowdown to quell inflation in 2023 and to prevent a de-anchoring of inflation expectations," she said.

U.S. dollar marches close to parity with euro, hitting 20-year high, and that is not good for gold price

Colin Cieszynski, chief market strategist at SIA Wealth Management, said that the broad-based drop in commodities, with copper falling to multi-year lows, signals that recession fears are replacing inflation fears.

"The underlying inflation pressure from commodity prices has started to ease," he said. "people are expecting a, a demand to come down as a global recession hits. That is why commodities are coming down," he said.

However, the question remains if a recession will cause enough demand destruction to impact the significant global supply issues. He added that this will determine just how persistent inflation will be through 2023.

Analysts have noted that the global economy faces fundamental supply issues. Tuesday Organization of the Petroleum Exporting Countries said that it sees oil demand growing to 102.99 million barrels per day, up from 100.29 million barrels per day forecasted for this year. The forecast suggests oil supplies could remain constrained next year as growth in non-OPEC output, which has been hit by Russian losses, lags the rise in demand.

Oil isn't the only market facing growing demand and weak supply. Copper prices have dropped sharply in recent weeks, but warehouse levels are at historic lows.

According to inventory data, LME warehouses held just 696,109 tonnes of registered copper at the end of June. Analysts have said that this is the lowest level seen this century.

"The big question out there is what will it take to get prices down? How deep of a recession are central banks going to have to force to get inflation under control?" said Cieszynski.

Although gold is oversold, Cieszynski said he couldn't rule out price testing support at $1,680 an ounce in the near term.

However, he added that gold continues to show some relative strength compared to other assets, particularly in the face of massive momentum in the U.S. dollar.

"Overall, gold has held up well when we compare it with what other currencies have done," he said.

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.