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Gold Hits Inflection Point

January 25, 2017

Even though the start of this year is trending awfully close to the beginning of 2016 for gold prices and USD, there are a variety of factors working to shift the narrative for the two assets. Although the boost provided by Donald Trump’s election has left uncertainty in its wake as policy points remain vague in all of the President-elect’s speeches, new figures suggest that monetary policy is to be tightened much quicker.

Remarks from Federal Reserve officials seem to signal that the dangers of heightened fiscal stimulus and deficit spending lie in adding upward pressure to inflation. This would lead to a much-accelerated timeline for interest rate increases. As the Fed’s mandate is met, any further trends higher in inflation could lead to accelerated tightening, leading to a boost to the dollar that would pull back most of gold’s recent rally.

Inflation Opens Door for Policy Tightening

A large part of the US dollar’s gains over recent months have been derived from Donald Trump’s electoral upset. With proposals to spend heavily on infrastructure, along with a sweeping tax restructuring and increased posturing on trade tariffs, Trump’s rhetoric pushed the US dollar index to its highest level in fourteen years. Nevertheless, the dollar pulled back after its torrid start to 2017 as Trump and Treasury Secretary nominee Steven Mnuchin talked down the strength of the dollar. Furthermore, with a majority of Trump’s policy proposals remaining vague, the dollar’s momentum has hit a wall.

Even so, the President-elect is not the sole factor influencing the greenback and thus gold. The Federal Reserve’s decision could also play a strong part in the debate, considering the fundamentals’ effect on the monetary policy outlook. Comments from several Fed officials likely point toward the Central Bank being slightly anxious about the effects of heightened fiscal spending, as it could lead toward higher consumer price inflation and therefore require a quickening of the timeline for proposed rate hikes. This would seem to indicate that the dollar could continue to climb on the back of the three proposed rate hikes in 2017.

With inflation having crossed the Fed’s preferred target of 2.00%, the door is open for the Fed to tighten monetary policy further. Inflation, which has dragged for the past two years as energy prices fell, has been on the rebound with both core and headline inflation meeting and surpassing the 2.00% mark. With the labor market also hovering near full employment, there remain few hurdles to rate hikes. Thus, the dollar could see an upward trend over the medium-term as other countries maintain highly accommodative monetary policies. This potential for the dollar means that gold will continue to experience downward pressure for the time being, and more so if the inverse correlation between the assets strengthens in future sessions.

Dollar Rally Could Crash Gold

Despite gold’s traditional role as a strong haven against consumer price inflation and broad uncertainty—both of which abound after Trump’s inauguration last week—strength in the dollar is probable to turn back gold’s momentum.  In terms of framing the current relation between gold and the greenback, the most recent correlation coefficient at -0.9205 points to a robust inverse interaction, signaling that a rise in one asset will lead to a fall in the other. Nevertheless, with the Fed signaling strong support for more rate rises, the dollar could reverse its current trade, therefore pushing gold prices down in the medium-term following a strong resurgence over the past month.

gold

Further piling on the bearish forecast for gold are momentum indicators that have hovered at or near overbought range. The Stochastic Oscillator is currently trending near overbought levels at 80.0, suggesting a potential retreat if the %D line follows the %K line below this key threshold.  Furthermore, should the Relative Strength Index cross below 50.0, downside momentum may accelerate. Although gold prices have the potential to keep rising, it risks running into long-term resistance at $1250. Nevertheless, any movement past that level would require sustained momentum to cross the 200-day moving average. Any pullback from actual prices would first need to cross the $1200 support before pushing downside support set at $1125.

Eyes on Upcoming Events

There are several key developments investors should keep in mind for the following weeks. The first is the Fed’s timetable for rate hikes and any potential for an accelerated schedule. Any remarks by President-elect Trump or Fed Chair Janet Yellen have the potential to distort markets and cause heightened volatility ahead of the FOMC decision on February 1st. Regardless, outside of comments on policy, the next major data report due before the FOMC’s February meeting is GDP statistics from the last quarter of 2016. A positive outcome will likely add to the momentum for the dollar, and further weigh on gold prices.