What Will it Take for Gold to Turnaround?

Gold prices have suffered sharply across 2022 with the market pulling back from initial strength to sink around 18% from YTD highs, now down around 7% from the yearly open.

The reversal in sentiment towards gold is indicative of a much bigger shift which has taken place in markets this year and can be linked to many factors. With gold prices now racing towards the 2021 lows, traders are now questioning whether price is likely to break through the lows and continue deeper or find support and reverse higher?

It’s important to look at the factors that are driving the current downside in gold and examine whether these factors are likely to change in the coming months or continue. 

Factors Driving Gold Lower

  • Central bank tightening
  • Rising global yields

Central Bank Tightening 

The main driver of the current downside in gold is the huge wave of centra bank tightening we are seeing in the wake of the pandemic. With inflation spiralling higher and higher, central banks across the G10 have been forced to aggressively remove pandemic-era stimulus and tighten monetary policy. 

Over recent months, the pace of the tightening we’ve seen from the Fed, the BOC, RBA, BOE etc has accelerated rapidly as have market expectations of further forthcoming tightening. This uptick in central bank action comes in response to the ongoing rise in inflation. With many central banks being forced to shift their view on inflation this year (from transitory to a more permanent increase), gold prices haven’t even derived support from their typical use as an inflation hedge. 

While gold has traditionally been used at times as an inflation hedge, the issue facing gold this time around is that we aren’t just seeing inflation in the US, and we aren’t just seeing a typical spike in inflation. The combination of post-pandemic demand, supply constraints and other COVID disruptions as well as the vast impact of the Russia-Ukraine war, means that inflation is soaring globally with many developed economies recording record inflation in recent months, with forecasts for further rises to come. 

Rising Global Yields

The sharp uptick in inflation this year means central banks have had to move quickly. In the US, the Fed has lifted rates from 0.25% at the start of the year to 1.75% currently. In Canada, we’ve seen rates move from 0.25% to 2.50%, and rates move from 0.1% to 1.35% in Australia. Other notable shifts include the SNB which announced a surprise rate hike last month, taking rates from the lowest in the world at -0.75% to -0.25%. The ECB is now on the verge of its first-rate hike in over a decade, reflecting just show acute the situation has become. 

So, with inflation spiralling globally and central banks being forced to act as quickly and aggressively as possible in a bid to bring inflation down, the backdrop for gold is not great. With yields surging around the world, a yieldless asset like gold cannot compete. As inflation continues to soar, so too do central bank tightening expectations, lifting yields further, thus depressing demand for gold. 

With this in mind, the near-term outlook for gold remains skewed towards further downside. However, traders are now starting to look beyond the projected tightening to anticipate what’s coming after and it’s important to make note of upside risks for gold. 

What might drive gold higher? 

  • Slower pace or suspension of Fed tightening 
  • Recession (global or US based)

Slower pace or suspension of Fed tightening 

Already this week we’ve seen some Fed members pushing back against the idea of a larger 100bps hike in July, following June’s 75bps hike. The US Dollar has come under sharp selling pressure this week as traders adjust their views.

This is a good indicator of the type of price action we can expect if the current narrative starts to shift. The key here will be a sign that inflation has plateaued and is starting to peel back. If we start to see signs of this over the remainder of the year. We can expect USD to begin reversing as investors pile out of long USD positions. In these circumstances, we can then expect gold prices to begin recovering. 

Recession (global or US-based)

One further factor is the growing concern over a potential recession later in the year, both in the US and globally. We’ve heard a number of central banks warning over a potential global slowdown as the combination of excessive inflation and tighter monetary conditions weighs on growth.

Should a recession materialise this would also likely be a catalyst for a reversal higher in gold. Not only would gold benefit from increased haven inflows amidst falling asset prices, but a slowdown would also inform the Fed’s decision to reduce or pause additional tightening, dragging the USD lower. 

However, until such time that near term (coming quarter) Fed expectations begin to shift lower (sub 50bps hikes, delayed hiking) gold prices look likely to remain under pressure. 

Let’s take a look at the technical picture to finish. 

Gold – Weekly Chart 

Source: FlowBank / TradingView

Gold double-topped above $2000 / oz and subsequently broke a rising trendline that was in place since 2019. The price is now testing major support at $1700 formed by the 2021 lows and 2020 high prior to Covid. Should the price break lower it opens up a possible drop towards the 2020 low around $1450 per oz.

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