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(Kitco News) - Inflation may have peaked in the U.S., giving the Federal Reserve room to end its aggressive monetary policy; however, the global threat has not abated, which will continue to support gold even as price volatility picks up.
Early Wednesday, gold prices tested support around $1,980 an ounce, falling to a two-week low after inflation in the United Kingdom came in hotter than expected, holding above 10% for the year in March. This is the seventh consecutive month that inflation has been above 10%.
According to some analysts, gold reacted to the British inflation data because it sparked fears that the inflation threat will reignite in the U.S., forcing the Federal Reserve to maintain its aggressive monetary policy stance and pushing the economy closer to a recession.
The latest data from the CME FedWatch Tool markets see a more than 80% chance of a 25-basis point hike next month. However, looking past May, expectations of a potential rate cut in the second half of the year are being replaced by more rate hikes.
"No one really knows where the Fed will be going from here, and if next month's 25bp hike – which is given more than 80% chance – will be the last one. The truth is, it will depend on inflation, really," said Ipek Ozkardeskaya, senior analyst at Swissquote Bank, in her daily research note.
Currency analysts at Brown Brothers Harriman said that the market's shift to price-out rate hikes this year could provide further support for the U.S. dollar, which in turn, would weigh on gold prices.
Michele Schneider, director of trading education and research at MarketGauge, said that if investors want to know where inflation is going, they need to pay attention to commodity prices, particularly food commodity prices.
The British data showed that food prices jumped 19.2% in the last 12 months, the biggest increase since August 1977.
Schneider said that years of low global farm production to support higher food prices has left the world vulnerable to further supply chain issues. Quoting a report from Fitch Solutions, she said rice production in 2023 is expected to see its worst annual production in 20 years.
The world could see a rice deficit of 8.7 million tonnes, according to Fitch. Pakistan, which produces about 7.6% of the world's rice, has seen its harvest plunge 31% because of the severe flooding last year.
Unfortunately, rice is the only the latest food added to a growing list of groceries that are seeing higher prices because of production issues. Coffee, sugar and wheat are all seeing solid price gains this year.
"The inflation cycle is not over. Inflation in the U.S. may have fallen from 9%, but it is still up 5% or 6% this year; that is still pretty high," said Schneider.
Persistently higher inflation is one of the reasons, Ole Hansen, head of commodity strategy at Saxo Bank, said in a note that he remains a long-term gold bull, even if prices continue to correct and consolidate lower in the near-term.
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"We believe inflation is going to be much more sticky with market expectation for a drop back to 2.5% perhaps being met in the short-term but not in the long-term, forcing a gold-supportive repricing of real yields lower," he said in his latest research.
Schneider warned that the growing uncertainty could create some volatility for precious metal prices. She added that prices could trade in a range between $1,950 and $2,015 an ounce.
"Right now, the market doesn't know what to be afraid of," she said. "Should they be afraid of the Fed raising interest rates higher and causing a recession or that they end the tightening cycle and inflation spirals out of control."
Despite the near-term volatility, Schneider said that she remains bullish on gold and any drop below $2,000 an ounce should be seen as a buying opportunity.
"$1,950 would be an unbelievable buy in this environment," she said.
Although gold prices dropped to a two-week low in initial reaction to the U.K. inflation data, it has since recovered and continues to hold support at around $2,000 an ounce. June gold futures last traded at $2,008.10 an ounce, down 0.57% on the day.
