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LAWRIE WILLIAMS: Positive gold momentum suggests breakout

The strong positive gold price movement at the end of last week confirmed our stated views of the considered effects of the likely U.S. Federal Reserve Bank (the Fed)’s moves envisaged at the mid-January FOMC meeting.  The immediate aftermath of the Fed’s likely more aggressive approach to try and control inflation was for the gold price to take a quite severe knock, but we said at the time that further consideration would likely see a gold price uptick, and so it came about.  The yellow metal’s price ended the week at just short of $1,860 – a big rise from the $1,780 level to which it had fallen in the days following news of the Fed’s likely more aggressive (hawkish) tightening programme, delivered in subsequent statements and Fed chair Jerome Powell’s post FOMC meeting press conference.

The adverse market reaction seems to have been a throwback to gold’s reaction to threats of Fed rate increase rises of a couple of years earlier.  The principal difference then, of course, is that the current high inflation levels had not yet made an impact.  This time around the latest official Consumer Price Index (CPI) figures for January showing an annual inflation increase of around 7.5%, have just been released, and this almost certainly understates reality.  A couple of years ago, the Fed had been struggling to encourage an annual inflation rise of even 2%, so an increase in interest rates would have had a much greater impact on a non-interest-generating asset like gold.  The current inflation rate suggests that even a series of more aggressive Fed interest rate rises will be insufficient to move real interest rates into positive territory and negative real rates are considered bullish for gold.

Raising interest rates, coupled with the forthcoming ending of Fed bond buying activity, due to be completed next month, is also deemed to be negative for equity prices,  Not only does the bond buying tapering cut off funding from the equity markets, but higher interest rates tend to reduce business profitability – something of a double whammy for stock prices.  Weakness in equity prices is also gold positive as it makes safe haven assets like gold more attractive to investors.

Geopolitical factors – notably the hysteria, as President Putin describes it - over a possible invasion of Ukraine by Russian armed forces, has also given something of a boost to gold.  The U.S. Administration has gone on record as saying a Russian invasion could happen as soon as Wednesday this week.  We are somewhat less convinced on this, feeling that the Russian troop movements on the Ukraine border are more likely to be sabre-rattling.  The likely casualty cost of an invasion would be too high given that the claimed size of the amassed Russian troops is pretty much matched by the likely size of a defensive Ukrainian army.  If Russia truly wishes to destabilise Ukraine it has the economic means to do so without the necessity of a military incursion.  President Putin has always been adamant that Russia will not invade, and although one’s confidence in believing political utterances is pretty low, he has much to lose if he breaks his word.  We may be wrong, but we shouldn’t have long to wait to see which conclusion is the more accurate.

If Russia does invade, then this would likely drive more investors into gold as a safe haven.  If tensions were to ease the opposite may occur, but we think that even if the latter occurs, the potential fallout from further consideration of likely Fed tapering moves will be sufficient to return gold to a rising path before too long.  The momentum looks to be positive for the moment.

Of course Western political posturing over the will they, won’t they invade scenario may just be an attempt to divert opinion from domestic problems.  If there is no Russian invasion then there will be claims that Western diplomacy has saved the day and kept us all out of World War 3, and the politicians will bask in their perceived success in so doing.  This may give U.S. President Biden and UK Prime Minister Johnson some additional much-needed brownie points – or am I being too cynical here?

It will be interesting to see how the gold price moves in the current week and beyond.  If the price holds – advances even – then we will definitely be back on track for a $2,000 gold price before the year end.  Indeed this may even prove to be a distinctly conservative forecast.  If gold falls back, perhaps due to a more aggressive than generally considered Fed, then all bets are off – but we still think the Fed may err on the side of caution with respect to interest rate rises.  An overly aggressive approach could rapidly cause a significant equity downturn and likely be responsible for tipping the U.S. into recession which would have a global knock-on effect.  Surely The Fed would want to avoid that happening?

13 Feb 2022 | Categories: Gold, Russia, US, FOMC, UK

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