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Gold price can still drop to $1,300 as investors exit 'underwater' ETF trades into year-end

Kitco News

(Kitco News) Markets are underpricing the risk of a bigger sell-off in gold into the year-end, according to Kathleen Kelley, chief executive of research firm Queen Anne's Gate Capital.

In 2020, many investors piled into gold as prices went from $1,600 to a new record high of over $2,000 an ounce. And based on ETF positioning before the big COVID gold-buying spree happened, investors might be looking at closing out more of their current positions that are underwater, Kelley told Kitco News.

"During COVID, a lot of people put part of their assets into gold, especially into ETFs," she said. "Everyone piled into gold ETFs, and gold ETFs went from 80 million ounces up to 110 million ounces. A lot of those purchases are now underwater."

In 2022, gold saw seven months of consecutive losses and was trading near the $1,600 an ounce level in October. Recently the precious metal caught a bit of a bullish wave as chaos in the crypto space following the FTX collapse pushed people into safer assets, such as gold.

"Right now, you've got a bounce in gold because of what's happening in crypto. A lot of assets are coming out of crypto, and some money is flowing back into gold. That has helped gold get through the $1,600 level, but gold will go back down soon," Kelley noted.

Live 24 hours gold chart [Kitco Inc.]

This year's overall trend has been significant outflows from gold-backed ETFs as investors exit positions that do not bring them profits. Yet, to get back to pre-COVID levels, investors still have some gold left to sell, Kelley added.

"You've come back down to 95 million ounces in ETFs. But back in 2020, we started around 75 million ounces. So, there are another 20 million ounces to come out of those ETFs that are underwater. And that pushes prices down to $1,300," she described.

Plus, gold is now facing a macro environment defined by higher interest rates and a stronger dollar.

"This means there are alternatives with a positive yield to them that have outperformed gold. As we go into year-end and people look at their portfolios and [potentially] take some tax losses, gold stands out as one of the obvious places to take it because you have better options with a positive yield," Kelley said.

And as gold returns closer to the $1,600 level, it could start to see heavier selling as investors who typically buy gold start to look more at Treasuries going into next year, she stated.

A lot hinges on what the Federal Reserve decides to do after its December meeting, but a Fed pivot is unlikely in the short term.

"I don't expect rates to go down. The Fed will probably stop raising rates as quickly, but you'll still have a positive backdrop for the U.S. dollar. And that will not be helpful to gold," she said. "Goods inflation is coming down. That's why seeing pressure come off in CPI and PPI. I would expect the Fed would raise by 50 basis points in December. Then I would expect a pause before the next hike. The Fed will continue to hike in Q1 of next year. However, it all depends on wage inflation."

To keep inflation expectations contained, the Fed will have to keep up its strong game plan on inflation. But at the end of the cycle, rates will be lower than most people expect, Kelley added.

"Europe and the U.K. are already in recession, and that's because of the energy market. The energy situation in Europe is much different than in the U.S. We think the economy in the U.S. will slow, and it needs to slow, but it will avoid recession. That is going to be one of the reasons why the dollar will continue to outperform," she pointed out.

But the bearish outlook on gold is temporary as all commodities are cyclical, and gold is not excluded from this.

"When you have high commodity prices, producers produce more, and consumers consume less because it is expensive. When you have low prices, the opposite happens," Kelley said. "Gold prices will go lower, putting pressure on producers, but demand will pick up because prices will come down quite a bit. Then you'll see prices start to go up again."

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.