Gold prices collapse to 14-week lows amid a stronger dollar: what’s next for gold prices?

The above-consensus US consumer inflation print of 8.3% last week, coupled with the Fed’s first 50 bps hike in 22 years resulted in a bloodbath on Wall Street. Investors and traders dumped their positions in essentially every asset class. The S&P 500 recovered some of its losses after testing the 3,800 level and is still down 1.1% over the past five days. 

The losses extended beyond the equity market and it seems that everything with a price sold off. Despite a reputation as a safe haven, even gold prices were hard hit. 

Gold sell-off 

Conventional wisdom would suggest that a recessionary environment, geopolitical clashes, and inflationary pressures, would be positive for gold prices. However, last week, gold was no stranger to furious selling pressure amid an elevated US dollar.

Global markets turned to the greenback, which gained momentum on hawkish expectations of accelerated interest rate hikes to quell inflation. The DXY, an index of the strength of the US$ versus a basket of reserve currencies, rose from 96.2 during the new year to a 20-year high of 105.1 on Friday, the 13th of March. 

It is clear that during these chaotic times, the world’s reserve currency, not gold, asserted its supremacy. The question is, can this trend reverse itself? Recent trading action certainly suggests this is not to be expected in the near-term.

The yellow metal plunged last week nearly 4% in its worst weekly performance in 11 months, registering a 14-week low and the fourth consecutive week of decline. Although it was above $1,900 as recently as the 5th of May, it toppled to $1,797.2 on expectations of accelerated rate hikes, only to cling to the $1,800 support level and close the week at $1810 following weaker bond yields.At the time of writing, gold is trading at $1,814.

The majestic highs reached in mid-March are now a distant memory, as frenzied market players unloaded their positions, reversing year-to-date gains, ending just 0.01% above January 3 prices.        

Important to keep in mind, gold’s much-vaunted legacy as an ancient store of value comes with no interest payments. Naturally, this is viewed unfavorably when interest rates are being hiked. Also, the strong greenback dissuaded purchases of gold priced in dollars. 

Most of all, gold derivatives are highly liquid. As investors rushed to cover losses in other classes, fill margin payments, and re-position portfolios for sticky inflation, paper gold was exchanged at a furious pace for the almighty dollar.

Dollar divergence

While the dollar price of gold saw a full reversal of year-to-date gains last week, interestingly, prices were 10.9% higher in sterling and 8.8% in the euro as of Friday, the 13th of March. 

At the close of the week, euro and sterling prices ended at relatively benign 6-week and one-week lows, respectively.

Year-to-date returns among the currencies were comparable until the first week of March, after which there has been a pronounced divergence. For the greenback, returns have fallen from 10% year-to-date on 10^th March to 0.01% at the close on Friday.

Higher volatility in the markets has fueled safe haven demand in the dollar, due to which the greenback has continued to strengthen.   

Muddy waters

Due to possible overselling in gold last week, the yellow metal will likely struggle to recoup its position.For the foreseeable future, traders can anticipate more volatility in gold prices forcing wider ranges.

Despite the Fed’s outwardly confidence, monetary management is far from an exact science, especially in such fast-evolving situations. If rate hikes come too quickly or too fast, the Fed risks turning a slowdown into a recession, or even worse. However, if rates do not keep pace with inflation, prices may rise to alarming levels while the Fed’s credibility is tarnished.   

This is especially problematic given that the USA has a debt culture. Much of consumption is driven by borrowing, commonly with credit cards. The high levels of personal debt mean that repayments become much harder when rates rise. This third dimension is perhaps the trickiest, as rate hikes come with social pain.  

Gold prices will likely suffer as rates continue to be hiked. But will this truly be sustainable?

During the previous rate hike cycle, the hardship of rising debt repayments was one of the reasons the Fed was forced to retreat from a seemingly low level of 2.5% in 2019.   

In other words, an optimal rate cycle requires quite a bit of good luck too.

Although Governor Powell remains steadfast in speech, it is uncertain if the Fed can continue to walk the talk, or if it will be forced to reverse course as conditions change.