Gold still weak under a tremendously strong dollar, but good times may return soon

The U.S. dollar remains exceptionally strong, which continues to be problematic for gold. The dollar has steadily increased over the last 12 months, approaching 110 on Thursday—its highest level in 20 years.

As a result, gold-backed exchange-traded funds saw a fourth consecutive month of outflows in August, an additional drag on the gold price, although those outflows were smaller than the 81 tons recorded in July. However, the metal bounced off $1,700 and appears to be holding that level for now.

A difficult summer for gold

In its August update on gold prices, the World Gold Council said the yellow metal's price fell 2% amid higher yields and the dollar's continuing strength. Although net positioning in managed money in gold shifted into the green for August, global gold ETFs recorded outflows of 51 tons of $2.9 billion compared to July's numbers.

August marked gold's fifth straight monthly decline in price. The metal bounced in mid-July, offering some promise of recovery, but it failed to break its key resistance level at $1,800 an ounce, running out of steam in mid-August.

Meanwhile, yields rose while the dollar retained its strength as the Federal Reserve reaffirmed its plans to continue tightening policy. Year to date, the gold price is down 5% in dollars, although its price continues to look better in other currencies, giving non-U.S. investors a boost. Despite the pullback in dollars, gold is still one of the year's best-performing assets.

Headwinds

The World Gold Council highlighted the headwinds facing the yellow metal, explaining that opportunity cost drivers like yields and the dollar were the most negative impacts on its August performance. However, momentum did offer a little relief to the gold price.

According to the council, managed money net longs in gold stood at 64 tons at the end of August, a reversion from the net-short position recorded in late July. The World Gold Council said short covering drove that reversion, and net long positioning remains low on a historical basis.

It believes the cooler CPI reading in July may have improved sentiment for gold slightly last month by temporarily boosting hopes of a Fed pivot. However, that dovish optimism dissipated after the Fed's Jackson Hole commentary, which firmly opposed the high inflation.

Outlook for gold prices

The World Gold Council noted that several Fed policymakers have clarified that it was too early to "declare victory" following July's slowing inflation read, so they might keep policy tight for some time. Fed Chair Jerome Powell reiterated that hawkish message at Jackson Hole at the end of August.

For now, interest rates will keep moving higher until the Fed pulls inflation down closer to its target. The central bank will update its forecast for monetary policy this month to offer more detail on what they expect for interest rates in the near term.

The European Central Bank and Bank of England are also dealing with multi-decade-high inflation, and they are also set for policy meetings this month. More rate hikes are expected, keeping the pressure on gold.

However, the World Gold Council believes investors are reluctant to accept that the Fed will keep hiking rates into next year. It said the markets are pricing in a reversal in the second quarter of 2023, potentially suggesting investors expect inflation to drop quickly or are looking for a deep recession that will force policymakers to rethink their strategy.

Good times for gold

According to the World Gold Council, the seeming divergence between the market's and the Fed's expectations on policy rates displays uncertainty. As a result, volatility could remain high across the financial markets. The organization believes the likelihood of a formal recession occurring "materially increased" last month.

It also pointed out that recessionary periods have been particularly good for gold, which tends to be one of the best-performing assets, especially when a recession coincides with high inflation. The World Gold Council added that the median return for gold during such environments has been 0.92%, higher than comparable asset classes except for U.S. Treasuries and corporate bonds.

The council also said gold has performed well during stagflationary environments. It sees support for gold as a hedge in the near term because inflation is expected to remain high for an extended period due to ongoing supply chain issues and tight labor markets.

The World Gold Council expects trading volumes for gold to rise this month due to a period of historically strong seasonal demand. Last month, gold volumes declined to $109 billion per day, far below July's $149 billion per day and the second-quarter monthly average of $126 billion.

As the market activity picks up, the council will continue watching positioning in gold futures and ETF flows, both of which indicate sentiment for the metal on a greater frequency than other indicators. Additionally, it expects demand among consumers to increase, especially in certain markets like India.