Gold has been a consistently solid investment over recent months. However, the shine is beginning to be taken off the performance. The drivers that have allowed gold to outperform other metals (that are deemed to be a higher risk) are starting to dissipate. This is leading to a retreat which could drag the gold price lower over the near to medium term. Looking further out, there is still a place for gold outperformance, which means that initial weakness could provide some interesting opportunities.
- Safe haven flow from the debt ceiling is reversing amid resolution hopes
- USD rallying is a drag on gold
- Yields are higher for now but are still likely to fall back
The US debt ceiling is highly likely to be resolved
The market fears over a default have been a drag on market sentiment in the year to date. This has helped to bolster the performance of gold, especially relative to other metals. The chart below shows how metals prices have faltered over the past month. However, gold has been holding up relatively well, with the safe haven flow allowing gold a far more steady performance than the volatility seen in other metals.
However, as US politicians move closer to an agreement this could begin to weigh on gold once more. There was a notable pick-up in metals on Friday as there was an element of brinkmanship played out in the debt ceiling negotiations. However, this should prove to be just near-term noise. As the talks resume into the final stretch, it is difficult to see how realistically there is any other option than to agree to raise the $31.4 trillion limit.
Raising the debt ceiling would reverse the safe haven flow that has allowed gold to perform well in recent months.
A stronger USD is weighing on gold
The performance of the USD has been curious in recent weeks. It has strengthened on the concern that the debt ceiling arguments may not be resolved (the USD as a safe haven). However, it has also been bought as the two sides have come closer to an agreement. With Treasury yields moving higher on the potential for higher for longer US rates, this has supported the USD.
So as the safe haven flow has reversed, the USD has been able to continue to pull higher. This has been weighing on the gold price.
The chart above shows a very strong negative correlation between gold and the USD. This has dominated price moves on gold for the past year. When I wrote about gold recently, safe haven flows were helping gold to pull in the same direction as the USD. However, this situation has flipped around again as the talks seem to be moving towards a resolution. As the USD is rallying, gold is faltering.
Higher US real yields weigh on gold too
There has been another notable move in recent weeks that is dragging on gold near term. Real yields have picked up. Nominal Treasury yields have increased more than inflation expectations and this has pulled the “real” yield higher (I look at the US 10-year Treasury Inflation-Protected Securities as a gauge).
Higher real yields are negative for gold because of the opportunity cost of holding an asset that does not yield anything. The strong negative correlation between gold and real yields is reasserting once more over the past week.
Is this just a near-term move?
This is all dragging gold lower in the near to medium term. The longer that the USD remains supported and that yields remain elevated, the deeper the correction on gold may become.
However, real yields are unlikely to move significantly higher from here. The peaks in the 10-year TIPS during Q4 2022 were between 1.60%/1.75% when markets thought that Federal Reserve interest rates could be moving towards 6%. At the current 1.40%, this may allow some additional upside traction, but not much.
Likely, gold will subsequently build support in the weeks ahead. It will likely begin to move higher again as bond yields fall back and the USD performance weakens again on improved risk appetite on the prospect of a new Fed rate-cutting cycle. If this happens because of a move towards a US recession, then this will only add to the appeal of holding gold in this scenario.
Technicals are faltering on Gold futures
With the decline in the Gold futures over the past couple of weeks, there has been a deterioration in the outlook on the technical analysis. The break below the support at $1970 completed a small top pattern within the uptrend channel. The top implies a retreat towards $1900 in the coming weeks.
Although there was a rebound on Friday, this move still looks to be counter to a growing near-term correction. The daily Relative Strength Index has been faltering over the past two months and is below 50. This points towards a mild corrective bias.
I will be watching the reaction to the resistance band $1970/$2004 over the coming week. If this becomes an area where the sellers once more make a move, then the formation of a lower high will develop. This would add conviction to my corrective outlook. A close below $1950 would then be the trigger for the next move lower.
