Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold rally continues despite need for consolidation
Ole Hansen
Head of Commodity Strategy
Summary: Gold continues to reach fresh cycle highs, supported by momentum and demand from traders and investors seeing an improved outlook as last year’s headwinds from rate hikes to rising yields and dollar strength become tailwinds as rate hikes eventually pauses while yields and the dollar softens amid concerns about the economic outlook. However, while hedge funds have increased their exposure to a nine-month high, investment flows into ETFs remain subdued, and if this divergence continues the market will eventually run into profit taking from non-sticky spec longs
Gold continues to reach fresh cycle highs, currently trading at a nine-month high near $1940, some 320 dollars above the November low and just 130 dollars below the March 2022 record high at $2070. The yellow metal is finding fresh demand from traders and investors seeing an improved outlook as last year’s headwinds, from rate hikes to rising yields and dollar become tailwinds as rate hikes eventually pauses while yields and the dollar softens amid concerns about the economic outlook.
The US Leading Indicator (LEI) fell sharply again in December as it continues to signal recession for the US economy in the near term said Ataman Ozyildirim, Senior Director, Economics, at The Conference Board. “There was widespread weakness among leading indicators in December, indicating deteriorating conditions for labor markets, manufacturing, housing construction, and financial markets in the months ahead. Meanwhile, the coincident economic index (CEI) has not weakened in the same fashion as the LEI because labor market related indicators (employment and personal income) remain robust. Nonetheless, industrial production— also a component of the CEI—fell for the third straight month. Overall economic activity is likely to turn negative in the coming quarters before picking up again in the final quarter of 2023.”
Except strong job reports, a recent spate of weaker than economic data have raised the risk of an economic slowdown which together with softening inflation may see the FOMC go into pause mode sooner than previously expected. The market is currently pricing in a peak in the Fed funds rate just below 5% to occur between March and June followed by a pause before a couple of rate cuts could see the rate end the year around 4.5%. Whether these market projections turns out to be correct or not is not the focus right now as traders and speculators are busy building exposure amid continued momentum.
The chart below shows the strong reaction in gold in the months and quarters that followed the three previous peaks in US rates during the past 20 years. The market is currently forecasting one or two further US rate hikes before pausing at or below 5%. Should history repeat itself, gold may have a significant further upside.
As stated before, we are looking for a price friendly 2023 for investment metals supported by recession and stock market valuation risks, an eventual peak in central bank rates combined with the prospect of a weaker dollar as well as continued strong central bank demand. In addition we still view the medium term outlook for inflation falling to below 2.5% as being somewhat optimistic, compared with our forecast closer to 4%. First, however, we will see several months where inflation will continue to decline before rising wage pressures, Chinas recovery lifting the cost of raw materials will be felt.
Regarding investment flows we have yet to see demand for ETFs recover with total holdings still holding near a two year low near 94 million ounces, having seen no pick up during the mentioned 320 dollar rally. Hedge funds meanwhile have been near constant buyers since early November, and during this time the net long has jumped from a 3.9 million ounce net short to a 9.3 million ounce net long, a nine-month high.
Traders' conviction at the beginning of a new trading year always tends to be low for fear of catching the wrong move. At the same time, however, the fear of missing out (FOMA) can also drive a rapid buildup in positioning which subsequently can be left exposed should a change in direction occur. In the short term these mechanics will have an impact on the price action in gold.
From a technical perspective there are no major level of resistance above before $2000 while support is well defined around $1900 followed by the ascending 21-day moving average line, currently at $1873. Levels that highlights the risk of deeper correction without the overall positive outlook being challenged.
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