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Gold hammered, analysts warn of capitulation event if price drops below pre-pandemic levels

Kitco News

(Kitco News) The gold market tumbled $40 Thursday and briefly fell below the $1,700 an ounce level as markets began to price in an oversized 100-basis-point rate hike from the Federal Reserve at the July meeting.

Rate hike expectations were quickly re-priced after the latest U.S. inflation numbers shocked the markets, with the annual CPI number coming in at 9.1% and the yearly PPI rising 11.3% in June.

Before inflation data, markets were looking for a nearly 100% chance of a 75-basis-point hike at the Fed's July 27 meeting, according to the CME FedWatch Tool. However, within 24 hours after the numbers were released, the expectations shifted to an 80.9% chance of a 100-basis-point hike. This would take the fed funds rate to a range of 2.50%-2.75%.

"Only yesterday morning, the market had just finally priced in a full 75bp rate hike in July for the first time. In a few hours, an above-consensus U.S. CPI reading and a surprise 100bp rate hike by the Bank of Canada changed the whole picture again. After these two events, markets have moved to seriously consider a 1.0% rate increase by the Fed in two weeks," said Francesco Pesole, FX strategist at ING.

The Bank of Canada surprised the markets with a 100-basis-point hike on Wednesday, warning that inflation will remain elevated for the next three months. 

"The Bank of Canada made the leap into triple-digit hikes shortly after the U.S. CPI release, acknowledging in the process that it had underestimated inflation since Spring last year," said Craig Erlam, senior market analyst at OANDA.

Gold faces many obstacles, but recession fears could help

The precious metal plunged below $1,700 an ounce Thursday, hitting 11-month lows and approaching pre-pandemic levels.

"A major capitulation event may be unfolding in gold," said Daniel Ghali, senior commodity strategist at TD Securities. "Gold bugs are falling like dominoes. With prices challenging pre-pandemic levels, risks of a significant capitulation event in precious metals are growing."

At the time of writing, August Comex gold futures were trading at $1.712.00, down 1.35% on the day.

"The yellow metal is feeling the heat from the inflation data and aggressive tightening in response. We could see its popularity improve once we see the peak in the inflation data, which we may now have in the U.S., but its tendency for upside surprises will leave investors cautious," said Erlam.

Downward price pressures have been rising in gold as the U.S. dollar index continues to trade at 20-year highs, yields advance, and oil sells off, according to analysts.

"Volatility around EUR/USD parity (which was hit yesterday) should continue to be elevated and to impact other USD crosses. We think that the current re-pricing higher in Fed rate expectations can – along with other factors – keep the dollar supported at this stage, and the risk of a more decisive break below 1.000 in EUR/USD can strengthen the greenback across the board," Pesole added.

A break below $1,700 is still very likely, with the next support level at $1,680 an ounce, added Erlam. "[But] once the peak is in place and we see signs of inflation pressures retreating, we could see gold back in favor as the economy drifts into recession."

Ghali noted that a drop below pre-pandemic levels, which is between $1,650 and $1,700 an ounce, could trigger even a bigger selloff in the precious metal.

"Pressure is building towards a capitulation if prices trade below their pandemic-era entry levels. In a liquidation vacuum, these massive positions are most vulnerable, which suggests the yellow metal remains prone to further downside still," he said.

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