Gold Rallying Amid Soft USD Conditions Ahead of FOMC
Gold has now more than recovered last Friday’s post strong US jobs data losses (which sent the precious metal as low as $1680), and is now trading firmly above the $1720 level, aided by continued weakness being seen in USD.
Before looking in more detail at the reasons, why gold is on the front foot this week, let’s look at why the precious metal was hit so hard last week.
As noted, very strong US jobs data on Friday was one factor in last week’s gold sell-off, but another big factor was last week’s sell-off in US government bonds. When the return you get on US government bonds improves (i.e., when bonds become cheaper), it becomes a more attractive investment relative to gold, hence the weakness we saw in the precious metal.
These two factors are undoubtedly gold negative, but market focus this week has switched back to gold positive factors, hence facilitating the rise we have seen so far this week;
Factor 1 - Growing expectations for action from the FOMC to cap the rise in US bond yields
Gold loves central bank stimulus from the FOMC full stop, but especially if it results in falling US government bond yields (as noted, falling US government bond yields make gold a more attractive place to leave your money).
There are growing expectations amongst market participants that the FOMC will unveil some form of yield curve control, a programme in which the FOMC would set a target yield for say 3-year US government bonds, and buy as much as is needed in the secondary market to keep yields at these levels.
If the FOMC does go down this route, this removes one BIG downside risk for gold - rising US government bond yields.
Factor 2 - USD continues its bear trend, which is gold positive
Gold prices have a negative correlation with USD and the dollar has continued its recent downwards trajectory in recent weeks. Why?
1) Broader risk on undermining the demand for havens, amid global economic reopening, continued improvements in economic data and flattening Covid-19 infection curves in key markets.
2) The continued dovish tone of the FOMC - the Fed continues to outprint the rest of the world’s major central banks combined, a HUGE drag on USD.
3) Unfavourable USD fundamentals, including a much lower US yield advantage over the rest of the world (thanks to the Fed axing rates to 0.0-0.25%) plus US economic underperformance (prior to Covid-19, the US was an economic outperformer amongst developed markets).
Goldman Sachs announced overnight that for the reasons outlined above, they maintained their forecasts for gold prices to reach $1800 within 12 months.
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