On May 8th, Assist FX expressed caution in prematurely poking the seafloor for a bottom in the paper gold market:
“Gold is not yet a clear buy as one might suspect with higher inflation. This is due to the risk of sharply higher interest rates still on the table. Higher real interest rates are an enemy to gold. We see two catalysts on the horizon to watch on the gold longs front. First, if higher interest rates harm economic strength enough to slow the expected trajectory of more front-end rate rises, gold can be bought in our view. Second, if the market begins to lose faith that the Fed will protect its already blurry mandate of stable prices, gold will smell blood in the water so to speak and catapult higher.”
The first of these two dynamics may be in the early stages of playing out, at the very least in the form of a pause in the marginal acceleration of short-end interest rate rise expectations in the US. It is apparent that the so-called “dollar shortage” witnessed globally has exposed significant emerging market carnage which cannot continue much longer at the same pace without running into a debt default contagion feedback loop leading right back to the front yard of the United States. Precious metals volatility has spiked during the past 3-days (as displayed in the featured chart of this post), which also coincides with a technical reversal pattern and speculative positioning data indicating that spec traders were caught off-sides short.
Additionally, 5-year inflation breakevens topped out in the spring and began rolling over. This will eventually feed into the Fed’s 2019 dot plot if it continues.
We see inflation expectations ultimately reversing higher again for a different set of reasons that will not lead to the same type of bearish run for gold witnessed this summer, but before that time the potential for even a modest backing off in Fed Funds rate hike expectations after 2018 should bolster the $1,170 per oz. support level. We like buying gold tactically on dips above this level.