Gold: a cautiously bearish outlook

This week, all attention will be on the midterm US elections, which might not significantly influence the short-term economic outlook.

However, changes in the election results could have implications for future politics and economic prospects.

The central question is who will control Congress? Will the Republicans maintain dominance in both chambers, or will the Democrats gain control of one or both?

US tariff policy and relations with Iran are two critical areas currently dependent on consistent policy.

Meanwhile, last week, as anticipated, the Federal Reserve opted to keep the target interest rate steady at 3.75 percent to 4 percent, though this decision came with a divided vote of 10-2, with two members dissenting in favour of a 0.25 percent increase.

The Fed Chairman’s statement clearly highlighted concerns regarding geopolitical uncertainty. It also pointed out that while the economy is growing, inflation remains elevated and needs to be addressed.

As such, the likelihood of a US interest rate hike in December is increased unless there is a significant downward revision of the economic outlook.

Fed Chairman Warsh’s remarks during his press conference reflected a hawkish stance on the economic outlook.

A significant change in the Fed’s policy framework beginning in autumn 2027 is that one meeting per year will not include a rate decision. Starting in 2028, decisions on interest rates will be made at only six of the eight annual meetings. The FOMC didn’t provide immediate details, which will be shared later.

Another noteworthy development from last week involved the movement of various assets, particularly the US dollar, treasury bonds, and the equity market, especially gold.

The NASDAQ experienced a substantial effect, especially within the technology and AI sectors, as investors became more selective about AI valuations.

The recovery in US bonds is notable, as two-year bond yields fell more sharply than those of ten-year bonds.

Over the last three weeks, ten-year bond yields declined by nearly 40 basis points. However, rising oil prices complicate this situation by exerting upward pressure on US. Interestingly, despite the equity sell-off, the dollar did not strengthen, nor did gold join in the typical upward trend that usually accompanies falling yields and a weaker dollar.

This can be linked to worries about inflation caused by oil prices and the unpredictability of the Fed, which complicates the broader situation and causes investors to lessen their exposure to different asset classes.

In light of the trend of rising oil prices and declining gold prices, my primary concern is whether the increase in US bond yields is sustainable, as these two phenomena create an odd and troubling combination.

I believe the decline in gold prices largely results from reduced central bank purchases. I have often argued in my posts that it is central bank buying that boosts gold prices, with traders typically following suit when purchasing orders for gold or currencies emerge.

Currently, the landscape has shifted; the traditional support for gold from central bank buying might be hampered by liquidity constraints arising from higher oil prices and potential liquidity issues.

Central banks now face costly energy imports, which pressure their foreign exchange reserves that need defending. Thus, immediate liquidity becomes a pressing concern.

In this context, China stands out as a potential exception, boasting foreign exchange reserves of around $ 3.4 trillion, while other central banks face dual risks. They require US dollars to stabilize their currencies. For central banks that have shifted portfolios into gold at high prices, they encounter three significant issues. Mark-to-market losses, liquidity challenges, and opportunity cost due to zero returns in gold.

This scenario means that for a central bank heavily invested in gold, a significant reduction in the market value of its reserve assets can occur. This matter goes beyond mere accounting. It impacts the central bank’s reserve valuations, capital positions, and public confidence in the communicated information. Most critically, gold does not yield interest or dividends.

While buyers facing high costs may hesitate to increase their exposure, it is important to note that unrealized losses alone do not necessitate selling.

It will be interesting to see if central banks become net buyers of gold in the present and forthcoming quarters.

For central banks that have accumulated considerable gold at elevated prices, there could be a significant drop in the market value of their reserve assets.

China, however, presents a different scenario. They might not be overly concerned with valuation losses since their primary goal is to decrease reliance on U.S. dollar-denominated reserve assets. Additionally, it is important to remember that central banks are not like commercial investment funds. They have objectives that extend beyond simply maximizing financial returns.

These can include pursuing financial independence, diversifying reserves, or safeguarding against risks such as sanctions or cross-border issues.

It is worth mentioning that, with some exceptions, not all central banks record their gold holdings in their income statements.

Currently, two factors that are negatively impacting gold are the weaker US dollar and declining US bond yields. In the current situation, gold is neither seen as a hedge against inflation nor as a safe haven, despite ongoing geopolitical tensions involving Iran, the US, and others.

Consequently, limited buying activity from central banks is unlikely to drive prices higher.

In this environment, gold has the potential to decline by another 5 percent to 10 percent, largely influenced by higher oil prices and shipping costs. The Federal Reserve is focused on its inflation target, and if inflation does not decrease, they may implement further interest rate hikes, which would be harmful for gold and its investors.

While gold investors will be seeking reasons to buy, I would prefer to adopt a long-term investment perspective until clearer trends emerge.

For this week, I will maintain a cautiously bearish outlook on gold, anticipating a possible rebound after a decline.

WEEKLY OUTLOOK - Nov 2-6

#GOLD @ $ 3876- This week, after a potential rebound in early Asia, a decline is anticipated. Key levels to monitor include support at $3810. On the upside, it must surpass $3990 to reach $4080 or $4120. Break of support levels could push gold towards $3750.

#EURO @ 1.1160- The Euro needs to maintain a level of 1.1060 for a correction. If it breaks above 1.1290, it will open the door for a move towards 1.1340.

#GBP @ 1.3388- The Pound Sterling has been enjoying strength thanks to economic growth and the potential for an interest rate increase. Nevertheless, it must climb above 1.3480 to sustain this strength, otherwise it will fall. On the downside, there is support at 1.3240, and a decline below that level could trigger a drop to 1.3180.

#JPY @ 157.58- The $/JPY pair needs to surpass 158.90 for the USD to explore higher levels. There is a risk of a decline below 156.50, which could lead to 155.40.

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