How far can Gold rally?

For over a month now, gold prices have been trending higher, gaining over 10% since the start of November. Naturally this poses the question of whether a new peak is coming, or will the precious metal keep moving up through next year. The prospect of inflation in the early part of 2023 might keep investors on the lookout for a place to store wealth. But there are things that central banks can do that might disrupt trends.

In order to guess whether gold prices will continue their current trend, it's important to get a good idea of why they have performed like this so far. While a diverse range of factors can be pointed to, the depreciation of the dollar has the largest contribution. In fact, since the start of November, the dollar has lost 8.5% against its basket of currencies. Suggesting that if we want to know whether the current trend in gold will continue, we have to see if the dollar is likely to keep weakening while going into the end of the year.

What's going on?

The dollar has been losing ground chiefly because investors are coming to believe that the Fed's extraordinary tightening is coming to an end. The dollar has been more attractive than other currencies over the past year, because the Fed was the most aggressive of the central banks in trying to curb inflation. Meaning that holding debt in dollars was more profitable than in other currencies.

But, with the Fed starting to "pivot" away from an aggressive stance, other central banks are expected to slowly catch up. The dollar's main advantage is expected to dwindle over the coming months. Then there is the question of what's going to happen in the first half of next year, when most economists believe the US will fall into a recession. And not one of those technically, debate on the definition, ones like the start of this year. Will the Fed hold firm with higher interest rates through the recession in order to bring inflation down? Or will they cave to political pressure and start easing to prop up the economy?

The China factor

Adding to the weakness of the dollar is a resurgence in risk appetite, thanks to China apparently moving away from its strict zero-covid policy to a more economically friendly zero-covid policy. This could help global outlook as China could return to buying more raw materials, and supply chains could be eased in the coming months. Increased productivity in the world's industrial base along with a weaker yuan could help reduce inflation, and ease some of the worries about a recession.

The markets are pricing in a 50bps hike by the Fed in December, a reduction of the pace recently. That would put it on track for a 25bps hike at the end of January. Then there is the option of one more hike sometime in the first half of the year, leaving the terminal rate at no more than 5.0%. So, if the Fed delivers next week, and there is a year-end rally in the markets, gold could continue to trend higher in the short term. But if the Fed were to double down on the hiking rhetoric, particularly in light of the stellar jobs numbers from Friday, the dollar might find some footing. And gold could falter a bit.