Bearish Gold Price Trend Persists

New York (Nov 22)  Stronger dollar has been weighing on gold price. Spot gold prices have fallen over 8.5% year to date, with lower prices spurring demand for the precious metal. Global demand increased 8% year on year to 1120.9 tonnes in the third quarter this year, driven by more buying of jewelry, coins and bars, while exchange-traded funds experienced outflows coupled with lower central bank and technology purchases, according to World Gold Council report.

The main determinant of gold price in recent years has been the Federal Reserve monetary policy. Gold price has been falling since September 2011 after it reached all-time high as inflation hedge demand for gold pushed the price for the precious metal higher with the implementation of monetary stimulus programs. The price has been declining since then as inflationary expectations subsided and the US dollar started strengthening. After the Federal Reserve ended its quantitative easing programs in October 2014, investors have been in anticipation for the shift to contractionary monetary policy and the first rate hike by the Federal Reserve in the last nine years. As the US economy continued to recover, Federal Reserve policy makers signaled their intentions to end the near zero interest rate policy and raise the interest rates in every policy statement since the start of 2015. The resulting strengthening of US dollar weighed on gold price, which fell below nearly six-year low of 1080 on November 12 after the release of stronger than expected October jobs report on November 6. Higher interest rates increase opportunity cost for owning gold which doesn’t pay interest, while stronger dollar makes gold more expensive for users of other currencies, depressing the demand for the precious metal.

The fall was not surprising - in October 28 interest rate statement, Federal Reserve policy makers explicitly mentioned they will be considering raising rates in December. The statement didn’t contain the reference to global weakness as a risk for US economy, which had been mentioned in September decision after August turmoil in international markets. Central bank policy makers stated they will assess progress - both realized and expected - toward the objectives of maximum employment and 2% inflation in making the decision. While inflation has been below the target level for some time, the surprisingly strong October jobs report provided a clear signal the labor market has tightened and is near full employment as unemployment fell to 5% from 5.1% in the previous month, and the average hourly earnings rose 0.4% on month. Treasury bond yields rose, strengthening the dollar to near 10-year high, as markets priced in the increased likelihood of interest rate hike in December.

Outlook dependent on rate hike prospect.

Since then, additional economic data bolstered the likelihood of interest rate hike in December – inflation in October increased 0.2% on month for the first time after two consecutive monthly declines. The increase was in line with expectations, as was the 1.9% year-over-year rise in core inflation, which excludes volatile food and energy prices. Further increases in inflation will depend on robustness of US domestic demand given the continued dollar strength, slowing growth in China and monetary easing in euro-zone and Japan. With labor market near full employment, a continued rise in earnings will nudge inflation higher, which will still be far below the target 2% level though. It will be then a matter of judgment on the part of Central Bank policy makers whether the inflation dynamics provides sufficient grounds for reasonable confidence that inflation will move back to 2% objective over the medium term. Chances of such development are better than fair, currently traders in Fed funds futures are pricing in 71.7% likelihood of December rate hike according to CME Group (O:CME) FedWatch tool. We believe the price of gold will continue falling toward the next psychologically significant support level of $1000/oz until then, unless unexpected negative economic data such as a surprisingly low second reading of third quarter GDP, weak durable goods orders, ISM services index or jobs report indicate a slowing of US economy and signal another possible delay of interest rate hike by the Federal Reserve. A retracement is possible in case of such negative economic developments, which may result in gold rebounding toward mid-October highs.