Gold builds support at $2,000, what's next?

Gold appears to have built solid support above $2,000 an ounce, but momentum to move higher in the short term has eased with uncertainty about the timing of Federal Reserve rate hikes.

But short-term sentiment aside, there are plenty of reasons to remain bullish on the yellow metal.

The Fed appeared to surrender to inflation at its December meeting. While the central bank held rates steady, it signaled three rate cuts for 2024 with another four cuts in 2025. That would lower rates to between 2 and 2.5 percent.  

The markets began anticipating this pivot late last fall, sparking a big rally in the price of gold.

But the December CPI report reveals a dirty little secret. The Fed clearly hasn't won the inflation fight. Both headline and core CPI remain far above the Federal Reserve’s mythical 2 percent target.

Fed officials have even tried to walk back expectations of rate cuts. Right after the December FOMC meeting, Federal Reserve Chairman Jerome Powell confessed, “Inflation has eased from its highs, and this has come without a significant increase in unemployment. That’s very good news. But inflation is still too high. Ongoing progress in bringing it down is not assured and the path forward is uncertain.” [Emphasis added]

Gold surged to a record high of around $2,135 in early December as rate cut mania took hold. But the yellow metal quickly sold off from that record level, tumbling well below $2,000 an ounce in the following week before rallying and consolidating above $2,000 after the Fed meeting. 

Where is Gold going from here in the short term?

It appears gold is currently undergoing a period of consolidation between $2,000 and $2,050 per ounce. This could set the stage for another big rally if the Fed goes forward with the anticipated rate cuts in the spring.

Currently, market sentiment seems to be mixed when it comes to the Fed. The December CPI report dampened rate cut enthusiasm, but optimism continues to bubble under the surface. Traders are still pricing in an 81 percent chance that the Fed will start cutting rates in March, according to CME's Fed watch tool.

Exinity Group chief market analyst Han Tan told Reuters, "Gold's window for posting fresh record highs should remain open as long as the Fed can move in line with market expectations."

The most recent data from the Commodity Futures Trading Commission Commitments of Traders (COTs) report showed money managers are liquidating long positions built up during the recent rate cut speculative mania. That would appear to be a bearish indicator. But on the other side of the coin, money managers seem reluctant to build significant short positions.

Long positions in gold futures in the managed money category fell by 20,051 contracts to 134,333. But short positions only increased by 639 contracts to 45,874. Net longs have fallen to a 2-month low of 88,459 contracts.

Meanwhile, safe-haven buying due to the ongoing conflict in the Middle East and robust central bank gold buying has supported the price of gold despite increasing big fund managers moderating their bullish stance.

“A tossup” might be the best word to describe market sentiment when it comes to gold right now.

A TD Securities commodity analyst told Kitco News that emerging doubts about the early timing for rate cuts drove the move out of long positions.

Strong labor markets are associated with continued inflation pressures. And with core CPI much above the two percent target, the market concluded that a very early Fed easing is not in the cards.

But bullish sentiments die hard. The producer price index for December showed easing prices and that may reinvigorate the bulls, according to the TD analyst.

But with the most recent production prices coming in at below expectations, the market is once again going long, as it anticipates an early end to restrictive policy. There will likely be data-driven volatility as gold trends to our $2,200/oz Q2 target.

Looking at the bigger picture for Gold

The markets are fixated on what Powell and other Fed officials say. The real question is what will they do?

It’s important to understand the broader trajectory of the economy as we consider where gold might go in the longer term. 

The reality is this economy is dependent on easy money. This is why the markets are desperate for rate cuts. Even if they won't say it out loud, everybody knows an economy loaded up with debt can’t keep plugging along in a high interest rate environment.

We’re already seeing the negative impact of higher rates with corporate bankruptcies at higher levels than during the pandemic. Meanwhile, consumers and the federal government are levered to the hilt.

Ultimately, I think the markets are right about rate cuts.  It seems certain that the Fed will cut interest rates in the near future whether the inflation genie is back in the bottle or not. (And it’s not.)

But the markets are right for the wrong reason.

The mainstream narrative is that the Fed has essentially won the inflation fight without wrecking the economy. The central bank can now give back the easy money the economy depends on, guiding us to a "soft landing."

But I think the more likely scenario is the Fed will be forced to cut interest rates more deeply and quickly than expected due to some type of crisis in the economy precipitated by higher rates.

Interest rates are at the same levels they were in 2006. After more than a decade of zero percent interest rates and trillions of dollars in money creation, there is even more debt and malinvestment in the economy now than there was then. If rising rates broke the economy and led to the Great Recession then, what makes anybody think things will be different this time around? Why should we expect a "soft landing?"

If (when) the economy does crash and there is some kind of financial crisis, the Fed will cut rates back to zero and it will relaunch quantitative easing. In other words, it will go right back to creating inflation. That's the fork the Fed knows. History tells us it won’t hold the line against inflation during an economic crisis.

And as I’ve said before – any declaration of victory over inflation is really a surrender. It's important to recognize any victory over inflation means the central bank is returning to inflationary policies. In effect, an end to rate increases, subsequent rate cuts, and loosening monetary policy will eventually lead to more price inflation.

In other words, as soon as the Fed declares victory, inflation wins. While you will likely see price volatility and some downward pressure on the price of gold as the markets digest every data point and try to read the Fed’s mind, it’s important to keep this bigger picture in mind.