Gold’s short-term outlook challenged by relentless yield surge

Looking at our gold monitor below, it is difficult to build a bullish case for gold if current developments were the only driver for the yellow metal. With the dollar and bond yields on the rise, the inverse correlation with a relatively stable gold has deteriorated, a development that has reduced selling pressures from algorithmic trading strategies, normally a major contributor to daily trading volumes.

In addition, as mentioned the tailwind from future rate cuts has also faded as the market price in a higher for longer scenario. A development which for now continues to see some asset managers vote with their feet when it comes to investing in gold through Exchange-traded funds, the reason being the high opportunity cost of holding a non-interest paying position relative to short-term government bonds. The current cost of holding a gold position for 12 month is close to 6%, the bulk of that being the cost of borrowing dollars for one year, and until we see a clear trend towards lower rates and/or a upside break forcing a response, real money allocators will be looking for opportunities elsewhere.

ETF investors which include the above mentioned group of real money allocators have been cutting holdings for the past four months, leaving the total down by 172.4 tons during this time to 2757.8 tons, a 3-1/2-year low. The leverage fund net long position meanwhile continue to hover around 60k contracts (6 million ounces), some 35k below the one-year average.

As mentioned in previous updates, the reason why gold in our opinion has been holding up well despite the mentioned headwinds, is likely to be a market in search for a hedge against the current negative market sentiment and most importantly, the FOMC failing to deliver a soft, as opposed to a hard landing. A hard landing or stagflation may occur if the Fed keeps the Fed funds rate too high for too long or in the unlikely event the economy becomes too hot to handle. Other drivers can be rising energy prices keeping inflation elevated while hurting economic activity or a financial of geopolitical crisis erupts.

Demand for gold as a hedge against a soft-landing failure is unlikely to go away as the outlook for the US economic outlook in the months ahead looks increasingly challenged. With that in mind, we maintain a patiently bullish view on gold while wondering whether the yellow metal in the short-term will continue to be able to withstand additional yield and dollar strength. The timing for a fresh push to the upside will remain very US economic data dependent as we wait for the FOMC to turn its focus from rate hikes to cuts, and during this time, as seen during the past quarter, we are likely to see continued choppy trade action.

Spot gold, in a downward trending channel since May, is currently stuck in a $1900 to $1950 range with additional dollars and yield strength raising the risk of a short-term break below which may see $1885 being challenged. A close back above the 200-day moving average, last at $1927, is likely to coincide with a break of the mention downtrend, opening for a fresh attempt to challenge resistance in the $1950 area.