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Gold Price Upside May be Limited as Real Yields Look Higher

Gold Price Upside May be Limited as Real Yields Look Higher

Warren Venketas, Analyst

GOLD FORECAST

  • ‘Inflation hedge’ may be fading.
  • Safe haven the last straw for gold.
  • Real yields turning weighing down on bullion.
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XAU/USD FUNDAMENTAL BACKDROP

Spot gold has enjoyed moderately elevated prices despite a hawkish Federal Reserve and soaring US Treasury yields. With roughly five rate hikes currently priced in (see table below) by markets for 2022, the upside potential for the dollar may be significant thus hampering bullion upside.

FEDERAL RESERVE INTEREST RATE PROBABILITIES

fed interest rate probabilities

Source: Refinitiv

With the current backdrop of rate hike expectations, US Treasury yields have been rising across the curve. The traditional inverse relationship between gold prices and Treasury yields is based around the increased opportunity cost (when yields rise) of holding gold as a non-interest bearing asset.

Real yields or nominal yield adjusted for inflation have an even tighter relationship with gold considered by many as an inflation hedge (although contentious). Since May 2020, US inflation has seen a consistent rise in CPI data in both core and headline prints leaving inflation outpacing nominal yields thus resulting in falling real yields (see chart below).

US TREASURY REAL YIELD CURVE RATES

US TREASURY REAL YIELD CURVE RATES

Source: Refinitiv

With US inflation forecasts seeing a peak in Q1 of 2022, the ‘inflation hedge’ appeal for spot gold may be dwindling adding to upward pressure on real yields as yields look to outstrip inflation. Later this week US CPI figures for January are expected and estimates reveal a further increase in inflation data. This falls in line with the Q1 peak outlook, and if actual data issues as expected or higher, the dollar should strengthen along with US Treasury yields leaving gold with substantial downside pressure.

US HEADLINE CPI FORECASTS (% CHANGE YOY, QUARTERLY AVERAGE)

US HEADLINE CPI FORECASTS

Source: J.P. Morgan Asset Management

Gold has been clinging to its safe haven allure in the midst of potential war between Russia and Ukraine. Should tensions dissipate in the near future, the prospect of a weaker gold price is highly likely.

TECHNICAL ANALYSIS

GOLD PRICE DAILY CHART

XAU/USD DAILY CHART

Chart prepared by Warren Venketas, IG

Spot gold price action has been trending higher of recent and still may have room to run short-term but a strong bullish rally from this point is unlikely. I believe the early January swing high a 1831.90 and possibly the 1840.00 psychological handle may be the frontier for gold bulls.

Price level resistance may coincide with the Relative Strength Index (RSI)trendline (red) which could realize profit taking and an increase in short positioning. Should the aforementioned fundamentals (higher CPI, higher US real yields and dismantling of Russia/Ukraine war threat) play out, the spotlight should be on the 1800.00 key area of confluence.

Resistance levels:

  • 1850.00
  • 1831.90

Support levels:

  • EMA levels
  • 1800.00

IG CLIENT SENTIMENT

IGCS shows retail traders are currently distinctly long on gold, with 75% of traders currently holding long positions (as of this writing). At DailyFX we typically take a contrarian view to crowd sentiment however, the recent change in longs and shorts result in a short-term bullish bias. This correlates with my above view as long-term with such skewed retail positioning, a downside correction is likely.

Contact and follow Warren on Twitter: @WVenketas

DailyFX provides forex news and technical analysis on the trends that influence the global currency markets.

DISCLOSURES