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Gold is just taking a break as interest rate expectations continue to shift

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(Kitco News) - With the weekend upon us, investors can close the book on a challenging and volatile month for the gold market.

May started with a lot of excitement as gold pushed to near record highs above $2,080 an ounce; however, that euphoria proved to be short-lived as we spent the next three weeks in a sharp downtrend with prices falling to a two-month low on May 31.

Although it’s disappointing that gold hasn’t been able to hold support and consolidate above $2,000 an ounce, for some investors and analysts, the short-term correction we have seen has not come as a major surprise.

We have seen this pattern repeatedly in the last 12 months. As weak economic data ignites new recession fears, markets start to front-run the Federal Reserve pricing in rate cuts. At the start of the month, markets saw a nearly 17% chance of a rate cut in June. At the same time, markets saw interest rates roughly 100 basis points lower by the end of the year.

These dovish expectations were completely at odds with what central bankers have been trying to tell investors. Inflation pressures have come down but are still too elevated for the central bank to signal any shift in monetary policy.

Now that we are less than two weeks away from the Federal Reserve’s next monetary policy meeting, reality is starting to set in. The 100-basis points of easing by year-end has been all but priced out of the market. At the same time, even if the Federal Reserve does leave rates unchanged in June, there is growing acceptance that there could still be one more rate hike this summer.

This new shift in interest rate expectations is creating a challenging environment for gold because it is supporting the U.S. dollar, which is trading at a three-month high. To top it all off, the summer is traditionally a weak seasonal time for the precious metal.

Despite the challenging environment that could keep gold from hitting all-time highs in the near term, there still remains significant long-term support for the precious metal. The biggest factor that will continue to support prices is central bank demand.

This week the World Gold Council released its much-anticipated annual Central Bank Gold Reserves Survey. Of 59 central banks surveyed between February 7 and April 7, roughly 24% said they planned to buy gold in the next 12 months.

“Gold's 'historical position' continues to be the top reason for central banks to hold gold, with 77% of respondents saying that it is highly relevant or somewhat relevant," the survey said.

Spot gold prices edge higher as eurozone inflation cools, ECB explores further rate hikes

One clear message we have heard from analysts is that central bank demand has completely transformed the marketplace. While physical demand doesn’t directly drive gold prices higher, the official sector is providing solid support and value for investors.

The survey also showed why investors should pay attention to central bank gold demand. The bottom line is central banks are buying gold for the same reason investors should. Central banks need to diversify their holdings, protect their currency’s purchasing power, and hedge against economic risks.

These are all issues that everyone around the world faces, and they are only expected to get worse.

The most significant risks continue to be a looming recession that inches closer every time the Federal Reserve raises interest rates.

While gold may be in a challenging environment, the one recommendation I keep hearing from analysts is that this is when you want to strategically build a position and take advantage of lower prices while you still can.

Thank you very much, and have a great weekend

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.