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OPEC oil cuts won't drive inflation high enough to stop gold's run above $2,000

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(Kitco News) - The gold market has room to move higher and retest resistance at $2,000 an ounce as rising oil prices are not expected to drive inflation higher, which will keep the Federal Reserve on track to lower interest rates in the second half of this year, according to some analysts.

Although gold is holding firm near its highest levels in a year, the focus at the start of the week is on oil as prices rallied 8% at the start of the session. Crude oil is getting a significant boost Monday as markets continue to react to Sunday's surprise production cut from the Organization of the Petroleum Exporting Countries (OPEC).

West Texas Intermediate crude oil is holding on to most of its early gains, last trading at $80.10 an ounce, up roughly 6% on the day.

Over the weekend, the global oil cartel said it would cut oil production by 1.16 million barrels per (bpd) day until the end of the year.  Saudi Arabia is leading the cuts after it announced it would implement a "voluntary cut" of just under 5% of its output, or 500,000 barrels a day, "in coordination with some other OPEC and non-OPEC countries."

According to some analysts, the rally in oil prices could complicate the Federal Reserve's and other central banks' efforts to bring inflation down. High oil prices can have a significant impact on inflation. Some analysts have said the production cuts could lead to oil pushing back to $100 a barrel.

"The reported one million barrel per day (bpd) curtailment is impactful and timed for maximum effect," said Peter McNally, global sector lead for industrials materials and energy at Third Bridge, in a note Monday. "With OPEC+ moving more aggressively to balance the oil market, the alternative sources of supply look limited and the price impact could be material."

Michele Scheinder, director of trading education and research at MarketGauge, said that if oil prices can see a sustained break above $82 a barrel, she would not rule out a move to $100. However, she added that this will continue to support gold prices as it shows that the Federal Reserve cannot control inflation.

While the rise in oil prices adds new uncertainty for financial markets, the rally is not big enough to worry the Federal Reserve, according to some analysts, which will further support gold prices.

Ole Hansen, head of commodity strategy at Saxo Bank, said that OPEC's production cuts are expected to bring the market more into equilibrium. He added that if oil prices continue to trade around $80 a barrel, it won't create a new inflation regime that will hurt gold.

"OPEC is seeing what gold sees, weaker growth later this year. Weaker growth means lower oil demand, so OPEC is a little frustrated with the price action and is just trying to be proactive," he said.

Hansen added that while $100 oil is inflationary, it would also push the global economy into a recession, ultimately lowering oil demand even further. "That is the last thing OPEC wants right now," he said.

Colin Cieszynski, chief market strategist at SIA Wealth Management, said that he also does not expect the OPEC cut to cause the Federal Reserve to change its current path, which is to leave interest rates unchanged.

He noted that if oil prices stay around $80 a barrel, they will still be down from last year's highs, meaning inflation is still slowing. "Inflation will still slow, just not at the pace the Federal Reserve would like," he said.

Cieszynski said that he sees gold prices continuing to consolidate between $1,940 and $2,050 an ounce, driven by ongoing safe-haven demand.

"Inflation is still under control, but there is still a lot of fear regarding the health of the banking sector and investors are worried about the next shoe to drop," he said. "This will keep gold well supported even as oil prices rise."

Hansen said that he also sees gold prices well supported. He noted that despite the OPEC cuts, markets still expect the U.S. central bank to cut rates before the end of the year.

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"Unless gold falls through support at $1,930 an ounce, we see anything else as a short-term price correction," he said.

Thorsten Polleit, chief economist at Degussa, said that although higher oil prices are inflationary, he expects adverse effects on the economy to significantly impact consumers.

He said that the contraction in the money supply and the current banking crisis are already signs that the world is headed to a recession.

"A decline in the supply of real money and real credit is like slamming on the breaks for the economy – and a further spike in energy prices would increase the odds of a severe recession, especially if central banks keep raising interest rates," he said.

Polleit said it is only a matter of time before gold prices break above $2,000 an ounce.

"The risks in the international financial architecture keep rising, and ongoing high inflation means that real interest rates will remain in negative territory – with no end in sight," he said. In addition, central banks could all too easily turn the current cyclical downturn into a severe recession. In such a scenario, there would be hardly any assets left that would deserve investor confidence – one exception being physical gold and physical silver."

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