Gold Price Analysis: XAU/USD drops back towards multi-month lows in the $1720s

What had looked to be a promising rally in spot gold prices (XAU/USD) during Monday’s Asia Pacific session, during which time spot prices rallied from the $1730s to session highs at $1760, was not to be. Gold was sold throughout the European and US trading session, dropping back to the $1720s by the end of US trade after resistance in the form of the 18 February $1760 low appears proved insurmountable. Bears will be on notice for a potential break below last Friday’s multi-month low at $1717 during Tuesday’s session. If this level does hold, however, a double bottom could be in the making, which would be a more bullish near-term technical signal and could portend a move back towards the $1800 region. On the day, spot gold prices closed 0.5% or just under $10 lower.

Driving the day

Gold bulls will be disappointed by the precious metal’s lack of reaction to the latest US ISM Manufacturing report ought to have got the short-term inflation warning lights flashing; But the Prices Paid subindex shot higher to 86.0, its highest level since 2008. According to Capital Economics, “higher oil prices and the depreciation of the dollar are putting some upward pressure on US prices this time around too, but the scale of the rise in the ISM prices paid index goes well beyond what can be explained by those factors alone”. The economic consultancy continues that “the comments in the report also make it crystal clear that these shortages go well beyond just semiconductors, with firms in every sector reporting shortages and problems with suppliers keeping up with demand”.

Amid further evidence of the build-up of inflationary pressures following this latest ISM report, ING comments that they now “expect inflation to rise above 3.5% in the second quarter”. Though the Fed has said that this expected increase in inflation will not be sustained and thus does not warrant a policy response, ING thinks “there is a growing risk inflation could end up being a little stickier around the 3% mark given the prospect of vibrant, stimulus fuelled demand coming up against a supply-constrained economy and businesses taking advantage to rebuild margins.” Thus, concludes the bank, though “the Federal Reserve tells us that they don’t think they will raise interest rates before 2024… we feel that this will be increasingly difficult to reconcile with the data… (and) mid-2023 looks increasingly likely to be the starting point for higher US interest rates”.

The lack of reaction in precious metals markets (which, given that they are seen as a hedge against inflation, typically rally on signs of inflation) is probably because they were more taking their cue from bond markets, which did not show any signs of concern. 5, 7 and 10-year US bond yields all dropped on Tuesday (not something that would happen if markets were concerned about short-term inflation). Real yields, meanwhile, were flat on the day, with the 10-year TIPS yield holding around the -0.73% mark.

Risk on in the stock market, with investors, focused on positive US fiscal stimulus (the House passed US President Joe Biden’s $1.9T stimulus package and the Senate will vote on it this week) and pandemic news (falling US infections, hospitalisation and deaths and the FDA approving the J&J Covid-19 vaccine), seems to have eroded demand for safe-havens. Meanwhile, the apparent lack of concern being expressed by the Fed towards rising US bond yields (which has supported the US dollar against the euro and yen) seems to be weighing on the US dollar given it signals that the Fed is happy to allow a modest tightening in financial conditions (bearish for gold) rather than jumping in to add further monetary stimulus to ease monetary conditions again (bullish for gold).

Week Ahead

Looking ahead, gold traders will have their hands full this week with the February ISM Services PMI report and February ADP National Employment out on Wednesday, followed by Weekly Jobless Claims and a speech from Fed Chair Jerome Powell on Thursday (comments to be released to the WSJ), ahead of the official Labour Market Report for February on Friday. All the while, gold traders will have to continue to track the path of the pandemic and vaccine/vaccine rollout news as well as the passage of Biden’s $1.9T stimulus package through the Senate and how this influences overall sentiment. If all goes well with these latter two, the stage should be set for further risk on (which could be gold negative). Meanwhile, weak US data would be the best for gold, given it would increase the strength of the argument in favour of the Fed keeping monetary conditions more accommodative for longer.