(Kitco News) - Although gold prices have struggled through most of 2022, investors' sentiment remains relatively elevated. Many analysts have said that investors are sitting on the sidelines, waiting for the Federal Reserve to "break" the global economy with its aggressive monetary policy stance before they jump back into the market.
According to one market analyst, the volatility in global currency markets could signify something has "broken."
Nicky Shiels, head of metals strategy at MKS PAMP, said that the unrelenting rally in the U.S. dollar is starting to create tension within the global economy.
"The BOE has pivoted, not because inflation has come down but to ensure financial stability. It's been widely noted that the Fed would hike until they break something (well, it's the U.K.) given the relentless strength of the US$," she said in a note. "When historical YoY changes reach 10-20% (it recently reached 21%), it's always associated with some financial or economic stress. Extreme dollar strength creates imbalances globally."
Financial markets continue to digest the unprecedented volatility in British markets after the government announced a fiscal plan valued at nearly £300 billion that would be covered through deficit spending.
The announcement caused the biggest selloff in recent history in the British pound. The selloff was contained Wednesday after the Bank of England said that it would buy long-dated U.K. government bonds, known as gilts.
The U.K. is only the latest victim of the U.S. dollar. Last week the Bank of Japan was forced to intervene in currency markets for the first time since 1998. The yen is trading at a 24-year low against the U.S. dollar. The euro continues to trade below parity with the U.S. dollar at its lowest point in over two decades.
While struggling against the U.S. dollar, the gold market is trading near all-time highs against all three major currencies.
Shiels said that gold investors should continue to look to trade gold in other currencies, especially where central banks have less aggressive monetary policy compared to the Fed.
"[Central banks] WILL respond in broken (F.X., Fixed Income) markets and intervene," she said.
However, Shiels said that she also sees potential for gold against the U.S. dollar as the currency looks overvalued. She noted that the greenback has rallied 7% over the last 12 days, which could signify a technical blow-off top.
At the same time, after falling to a new two-year low, gold prices saw a strong bounce back above $1,650 an ounce Wednesday. December gold futures are holding on to most of those gains, last trading at $1,668.20 an ounce, down 0.11% on the day.
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"Now, clearly we don't know if the US$ has already peaked (it can extend especially given all the bearishness around U.K./Europe into Winter, ongoing war & recession risks), but from a structural perspective, technically and given historical context, the US$ is nearer the end (the DXY top) than the bottom; Gold is getting nearer its floor," she said.
Shiels noted that historically, when the U.S. dollar has peaked, gold prices have rallied around 6% in the subsequent two months.
As to what could signal a top in the U.S. dollar, investors will have to watch how aggressive the Federal Reserve will continue to be with its monetary policy. Last week the U.S. central bank signaled that the current tightening cycle could peak at 4.6% next year.
However, Shiels said that the growing stress in currency markets could force the Federal Reserve to take a less aggressive stance at its November meeting.
"The Fed, despite ongoing deglobalization, cannot act unilaterally or run monetary policy in a vacuum; there are likely backchannel dialogues occurring between, especially G-10 allies like the U.K. and Fed. So there is now a rising probability of 'only' a 50bp hike in November, which is underpriced in markets," she said.
