Gold is facing a major test of investor appetite as the Federal Reserve begins its long-awaited pivot to lower interest rates.
The precious metal extended gains from Wednesday’s surge after Fed policymakers said they expect to cut interest rates by 75 basis points next year. Cooling inflation had already prompted investors to position for easing, sending bullion briefly to a record last week.
With monetary easing now definitely on the agenda, gold traders will be watching for the return of big-money investors, who could set the stage for a more sustained rally after two years on the sidelines. They have long shunned non-interest-bearing bullion as inflation-adjusted Treasury yields have risen to their highest levels since the financial crisis.
That’s led to sustained outflows from gold-backed exchange-traded funds, a major headwind for the precious metal. But with bond yields falling as the Fed signals an easing in 2024, that could be about to change.
“The return of an environment that’s conducive to financial inflows into gold is clearly happening,” said Marcus Garvey, head of commodity strategy at Macquarie Group Ltd. “Going into next year, I’m still very bullish.”
With prices just shy of the $100 record set in a chaotic trading session last week, investors may be wary of entering the market. Gold also still trades at a significant premium to real Treasury yields – one of its biggest drivers – on a historical basis.
This premium has been in place for well over a year, thanks to record central bank buying which has helped to offset investor selling. It appeared to be on the verge of closing in September as gold tumbled, before the Hamas attack on Israel sent prices soaring on a wave of short-covering.
Even as fears of the conflict spilling over have receded, gold has continued to trade at elevated levels, providing a high base from which prices can rally. Even a small resumption of ETF buying would have a big impact on sentiment.
“With central banks sucking more than 1,000 tonnes out of the market for a second year, the selling by ETF investors has been easily absorbed,” said Ole Hansen, Head of Commodity Strategy at Saxo Bank A/S. “What happens if both potentially become buyers next year?”
The extent of any new buying is likely to be determined by the pace of Fed rate cuts in the new year. Currently, swap traders are pricing in almost twice as much easing as the central bank signalled on Wednesday, potentially leaving gold vulnerable to pullbacks if it takes a cautious approach.
“There is no need for a rapid turnaround in US monetary policy,” said Carsten Menke, an analyst at Julius Baer Group Ltd. “We therefore see gold and silver prices on a soft footing.”
All eyes will remain on US economic data next year, with higher-than-expected inflation or robust employment figures likely to disappoint those betting on multiple rate cuts.
“The market will inevitably be disappointed in terms of the path from here to rate cuts at some point,” says Macquarie’s Garvey. “I can see it continuing to be two steps forward, one step back.”
Spot gold was up 0.9% at $2,046.58 by 10:14 a.m. in New York. Other precious metals also rose, with spot palladium up as much as 7.9%, its biggest intraday jump since March.
