As the US banking crisis has soured risk appetite, and the Federal Reserve has turned more dovish, this leaves gold primed to retest the highs.

Fundamentals and technicals are aligned for gains in gold

Since the recovery in gold kicked into gear in November, the rally has been impressive. However, moving towards the end of Q1 2023, the stars have become aligned for further upside in gold.

We see strong fundamental and technical reasons for believing that gold will continue to move higher and could be set to retest its all-time highs once more. 

Here is what we see: 

  • The dovish shift from the Fed is positive for gold: The March “dovish hike” is boosting gold amid USD weakness and falling bond yields
  • The US banking crisis supports the safe haven of gold: Gold has performed well as risk appetite has soured.
  • Central bank demand for gold is strong: Central banks are buying huge amounts of gold in recent months.
  • Technicals show breakouts and strong momentum: This suggests buying into weakness for further gains.

A dovish hike from the Fed

The Federal Reserve interest rate hike on Wednesday could be the end of its monetary policy tightening.

The FOMC raised the Fed Funds target range to 4.75%/5.00%. However, there were plenty of hints that this could easily be the last.

It was a “dovish hike”:

  • The FOMC statement was changed from additional policy firming will be appropriate” to “may be appropriate”.
  • Fed Chair Powell stresses that the banking stress could trigger a credit crunch and a “significant macroeconomic effect”.
  • The dot plots of interest rate projections for the end of 2023 were unchanged at a median of 5.1%.

Markets are taking this that in the face of a growing banking crisis in the US, the Fed could now be done.

Looking at market reaction, this seems to be the case:

Fed Funds futures show the peak rate is below 5.00%, but also that the first rate cut could now be as soon as July!

This is reflected in the CME Group FedWatch tool which now shows just a 25% chance of a hike in the next meeting in May.

We think that this dovish shift from the Federal Reserve will be negative for the USD in the coming weeks.

In turn, a weaker USD should be supportive for gold.

A weaker USD and falling yields are strong for gold

The dovish Fed amid the banking crisis in the US is having a significant impact on US bond yields. It should also continue to weigh on the USD too.

Lower yields and a weaker USD is positive for gold.

Falling yields are positive for Gold

When analysing gold, we tend to look at the correlation with US bond yields, specifically the US 10-year real yield.

As US Treasury yields have fallen sharply but US inflation expectations have held up relatively, this has dragged the “real” yield lower. (The “real” yield is the nominal yield minus inflation).

In market terms, the real yield is measured by US 10-year Treasury Inflation-Protected Securities.

Gold has a very strong average correlation of -0.50 with real yields over the past 12 months.

Falling yields are positive for gold.

USD weakness is very positive for gold

However, when looking at the relationship with the USD, there is an even stronger negative correlation with gold.

As can be seen in the chart, the negative correlation is extremely strong, averaging -0.66 over 12 months.

The chart of gold is almost a mirror image of the Dollar Index.

Subsequently, if the USD continues to weaken, this will be positive for gold.

Gold is a safe haven and a central bank’s favourite

The recent US banking crisis has helped to increase the gold price. However, on a medium to longer-term basis, central banks are also helping.

US banking crisis drives safe havens

The US banking crisis has been negative for risk appetite. The fear of contagion in the banking industry and flashbacks to 2008 have stoked demand for safety. 

This has driven investors towards assets such as gold.

Since the sudden collapse of Silicon Valley Bank on 10th March, gold has rallied by c. 9%. 

Central banks have significantly increased gold purchases

The demand for gold has had a significant boost in recent months.

Looking at the data on net sales/purchases of gold by the world’s central banks, there has been a sizeable increase since the middle of 2022.

The chart below was compiled by gold consultant, Dan Popescu.

The chart shows that there were record purchases of gold by central banks in Q3 and Q4 2022. According to the World Gold Council, prominent buyers included the Central Banks of Turkey and the People’s Bank of China.

This increase in demand has also reportedly continued into Q1 2023, with a net of +31 tonnes added in January.

According to the World Gold Council, around 17% of the world’s total gold is held by central banks. Subsequently, this boost in demand would have had a part to play in the gold rally since November. 

If this strong net positive demand continues, then it will continue to help to support the gold price.

Strong technicals point to further upside for gold

There is also a strong outlook on the technical analysis of gold.

We can see a sharp run higher in the past couple of weeks. 

breakout above the key resistance of the $1960 February high is the next important step in the recovery within a medium-term uptrend channel.

If the price closes above $2000 it would then open the way for a test of the long-term key resistance of:

  • The high in the wake of the Ukraine war at $2070
  • The all-time high (in the wake of the COVID breakout) at $2075 

Here are a few other positive aspects of the technical analysis:

  • Momentum is strong with the RSI in the high 60s, this suggests that weakness is a chance to buy.
  • The 21 and 55-day moving averages are rising and have just posted a “golden cross”.
  • There is good near-term support between $1930/$1960.

Subsequently, we favour using weakness as a chance to buy gold and believe that a retest of the key highs could be seen in the coming weeks.

This material is for general information purposes only and is not intended as (and should not be considered to be) financial, investment or other advice on which reliance should be placed. INFINOX is not authorised to provide investment advice. No opinion given in the material constitutes a recommendation by INFINOX or the author that any particular investment, security, transaction or investment strategy is suitable for any specific person.

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