Quarterly Outlook
Fixed Income Outlook: Bonds Hit Reset. A New Equilibrium Emerges
Althea Spinozzi
Head of Fixed Income Strategy
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Gold stabilising ahead of support
Ole Hansen
Head of Commodity Strategy
Summary: The gold ship has steadied following a four-day correction that was triggered by long liquidation from funds in the futures market after it failed to break key resistance. With ETF investors still missing on the buy side, the dollar's inverse correlation remains a key source of directional inspiration as the metal now search for suppport in the $1735 area.
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The gold ship has steadied following a four-day correction that was triggered by the yellow metals inability to break resistance at $1788 per ounce. That failure triggered long liquidation from funds who had just added the most length in COMEX gold futures since June 2019. That reduction is now showing signs of having run its course with buying emerging at the former resistance level, now support at $1735. In a recent gold update before the metal sector received a boost from a weaker dollar and lower US bond yields, we highlighted the importance of $1735 as the trigger for a potential change in the trading behavior from selling into strength to buying into weakness. It is this potential change in sentiment that is now being tested.
Overall, the dollar's inverse correlation to precious metals and commodities remains a key source of directional inspiration for traders and algorithmic trading strategies. Since the November 3 low at $1615, gold has bounced by around 7% while the broad Bloomberg Dollar index trades down by close to 5%. In addition the recovery in gold has been supported by a 30 basis point drop in US ten-year real yields and a key part of the US yield curve inverting the most since the early 1980’s, thereby signaling an increased risk of a recession hitting the US economy next year.
A recession hitting before inflation has been brought under control remains one of our main reasons for keeping a bullish outlook for gold into 2023, but with ETF investors still cutting exposure despite the recent recovery, the metal needs continued support from declines in yields and the US dollar or some other catalyst that sees a run to safety.
Hedge funds were aggressive buyers of COMEX gold futures during a two-week period up until last Tuesday, November 15. During this time they bought 80,000 contracts or 8 million ounces, the strongest two-week buying pace since June 2019. As a result the net positions flipped from a short to 41k contract net long, a three-month high. However, the failure to break above key resistance in the $1800 area has left the metal exposed to a setback, hence the renewed focus on resistance-turned-support at $1735.
One of the reasons why gold did not break higher last week was the continued absence of longer-term focused buyers through bullion-backed ETFs. Since the November 3 low and later rally, total holdings have seen a 210,000 ounce decline to the current 94.2 million ounces, thereby extending an almost non-stop pace of reductions since April. With ETF investors still sitting on the fence, another key source of support appeared during the third quarter from central banks. The Gold Demand Trends Q3 2022 update from the World Gold Council out earlier this month showed central bank demand reached a quarterly record of nearly 12.9 million ounces, thereby offsetting a 7.3 million ounce outflow from bullion-backed ETFs.
At Saxo, we maintain a long-held view that the inflation outlook will likely surprise to the upside with a 4% to 5% range over the next decade not being that outrageous. Driven by a new geopolitical situation where the world is splitting into two parts with everything evolving around deglobalization driven by the need for self-reliance. Together with the energy transition, we are facing a decade that will be commodity and capital intensive, and where scarcity of raw materials and labor will keep inflation elevated for longer and higher than the 2.6% level currently being priced in through the swaps market.
Such a scenario combined with the risk of an economic slowdown forcing a roll over in central bank rate hike expectations, sending real yields and the dollar lower, may in our opinion create powerful tailwinds for gold and silver during 2023.
Having failed to break resistance at $1789, the 38.2% retracement of the 2022 selloff, the recent bounce can still only be described as a weak correction within a downtrend, and for that to change the break above is needed. In the short term the focus stays on $1735 support and the markets ability to attract fresh buying interest. Failure to do so would likely trigger more selling, initially to $1722 and potentially as deep as $1700.
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