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Gold to Fall Further on Easing Inflation Bets, US Dollar Gains

Gold to Fall Further on Easing Inflation Bets, US Dollar Gains

2011-06-25 01:10:00
Ilya Spivak, Sr. Currency Strategist
Gold_to_Fall_Further_on_Easing_Inflation_Bets_US_Dollar_Gains_body_Picture_5.png, Gold to Fall Further on Easing Inflation Bets, US Dollar Gains

Fundamental Forecast for Gold: Bearish

Back at the beginning of May, we argued that gold appeared to have topped just below the $1600 figure after the Federal Reserve announced it would allow the second round of quantitative easing (commonly called “QE2”) expire at the end of June, with the implied rise in yields through the second half of the year weighing on inflation expectations and sapping demand for the yellow metal as a hedge against runaway price growth. Prices indeed tumbled, hitting the lowest level in a month, but a dramatic deterioration in US economic data over the subsequent weeks sowed seeds of doubt that Bernanke and company would truly begin to withdraw stimulus. Prices began to reverse higher, erasing close to three quarters of the initial plunge.

This week, the selloff looks to have resumed. This seem only fitting after the Federal Reserve set the record straight on how it plans to reconcile slowing growth with the end of proactive stimulus. Ben Bernanke told the markets that while the recovery was disappointingly slow – even downgrading the Fed’s official economic growth forecast for the remainder of the year – QE2 would be allowed to pass without an expansion of support on the horizon. Gold prices took notice, issuing the largest drop in seven weeks, while 2-year priced-in inflation expectations (derived from bond yields) fell to the lowest since early January.

Looking ahead, more of the same is likely in the coming week, with downward pressure compounded by a rally in the US Dollar. Traders have looked to the benchmark currency as a safe haven, mirroring a familiar dynamic witnessed at times of stress during the 2008 Great Recession and its aftermath, amid increasing signs of economic slowdown in all three of the world’s leading growth engines (China, US, Europe) and resurfacing Euro Zone debt crisis fears. The price of gold on global markets is denominated in US Dollars, so appreciation of the benchmark currency produces de-facto headwinds for the yellow metal.

EU policymakers unveiled a second round of aid for Greece – the poster-child for the sovereign turmoil on the currency bloc’s periphery – at a summit in Brussels this week. The Mediterranean country’s parliament must now ratify the package, which is tied to additional austerity measures, on Tuesday. The vote is likely to register in the affirmative considering Greek Prime Minister George Papandreou survived a confidence vote last week that was called with the sole purpose of giving him the mandate to push through further fiscal retrenchment measures. By allowing him to stay, Greek lawmakers have already rubber-stamped additional austerity, with next week’s vote looking essentially like a formality.

Still, investors are likely to be jittery ahead of the final outcome due on Tuesday, putting upward pressure on the greenback. While the successful passage of the new aid plan is likely to yield a temporary boost to risk appetite, the spotlight is likely to quickly move back to macroeconomic concerns ahead of Friday’s NFP release, weighing on optimism anew and engineering further gains in the greenback and help push gold lower.

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