Weekly Gold Review: Gold prices hit an 11-month low, US inflation exceeding 9% leaves the FED no choice but to continue its course

This week Spot gold fell by about 2.14%, a slowdown from last week's 3.63% decline. However, this marks the fifth consecutive week of decline for gold prices, with intraday lows hitting $1697.53, the lowest since the week of August 13, 2021. US inflation rose to a more than 40-year high of 9.1% year-on-year, significantly boosting expectations of faster interest rate hikes by the Federal Reserve and suppressing gold prices this week. Accordingly, this week US Dollar Index (108.0071,  -0.6522 ,  -0.60% ) rose by about 1.42%, hitting a near 20-year high of 109.3032 since the third quarter of 2002, marking its third consecutive week of gains.

US economic data in June strengthened expectations of faster interest rate hikes, US Dollar Index hitting a near 20-year high, gold under pressure

The US Bureau of Labor Statistics' CPI report for June showed that overall inflation remained stubbornly high, reaching 9.1%, unseen since November 1981, higher than May's 8.6% and above the expected 8.8%.

Gasoline, housing, and food indexes were the biggest contributors, with energy remaining the top concern. The energy index rose 7.5% month-on-month and 41.6% year-on-year, the largest 12-month increase since the period ending in April 1980. Rising energy costs accounted for nearly half of the increase in all items.

The core CPI report, which excludes food and energy costs, showed a slight decline. In June, the index for all items excluding food and energy rose 0.7%, bringing core CPI down from 6% in May to 5.9% in June, higher than the expected 5.7%. Core inflation offered some relief to the market.

The Bank of Canada unexpectedly raised interest rates by 100 basis points on the same day the US CPI data was released, admitting it had underestimated inflation since last spring. It also warned that inflation would remain high for the next three months. The Bank of Canada's aggressive rate hike put pressure on the Federal Reserve.

The following day, the US Bureau of Labor Statistics released the PPI report for June. The report showed that overall PPI rose 1.1% from 10.8% in May, up 11.3% year-on-year, the largest increase since March 2022 when PPI rose 11.6% year-on-year, higher than the expected 10.7%. Core PPI was 8.2%, down from 8.3% in May, but higher than the expected 8.1%.

The June CPI and PPI reports clearly show that high inflation persists. If June wasn't the peak of inflation, July and August could be worse, as the market previously believed May was the peak. This level of high inflation will certainly force the Federal Reserve to take urgent action, making its already aggressive stance on inflation even more aggressive. The Federal Reserve has long prioritized inflation concerns over economic growth, and curbing inflation is currently the Federal Reserve's top priority, even at the risk of pushing the US economy into recession.

Following the release of the inflation data, traders suggested that the Federal Reserve could raise interest rates by a full percentage point at its July FOMC meeting. After that, the Federal Reserve would raise rates by another 75 basis points at its next FOMC meeting in September. Although Federal Reserve officials later downplayed such expectations.

Generally speaking, there is a 100% negative correlation between the value of the dollar and the price of gold. This is because the dollar and gold are paired, so a strong dollar is directly related to a weak gold, or a weak dollar is directly related to a strong gold. A significant acceleration in the rise of US interest rates will also increase the real yield on government debt instruments. Higher yields reduce the attractiveness of gold, as it does not offer any interest income, in which case people turn to these fixed-income assets and temporarily leave gold. With US Dollar Index continued climbing to near 20-year highs, rising US Treasury yields, and oil sell-offs, downward pressure on gold prices is increasing.

Institutional Views

Daniel Ghali, senior commodity strategist at TD Securities, pointed out that if gold prices fall below pre-pandemic levels, i.e., $1650 - $1700 per ounce, it could trigger larger-scale sell-offs. He said: "If gold prices fall below pre-pandemic entry levels, pressure to surrender is building. In a vacuum of liquidation, these large positions are most vulnerable, suggesting that gold prices still have a tendency to fall further."

Craig Erlam, senior market analyst at OANDA, said: "Gold prices are feeling the heat from inflation data and the pressure of responding to aggressive tightening policies. Once US inflation data peaks, we may see its popularity improve, but its unexpectedly upward trend will make investors cautious."

Commodity analysts at CPM Group said in a report to clients: "While theoretically gold should benefit from higher inflation data, the reality is that higher inflation data suggests that the Federal Reserve may raise interest rates more aggressively to curb strong inflation. This will lead to a stronger dollar against other major currencies and suppress future inflation expectations."

Although gold is oversold, Colin Cieszynski, chief market strategist at SIA Wealth Management, said he wouldn't rule out a test of support at $1680 per ounce in the near term. However, he added that gold continues to show some relative strength compared to other assets, especially given the significant strength of the dollar. He said: "Overall, gold has performed well compared to other currencies."

John LaForge, head of real estate strategy at Wells Fargo, said: "Gold needs its own rally—about 17% now—to reach our target of $2050 per ounce at the end of 2022. Currently, our year-end 2022 target remains unchanged because 17% is achievable. With a recession looming, gold is relatively cheap compared to most other commodities, and investors may start buying. That said, we know time is running out, so we're reviewing our target."

The CFTC's disaggregated trader report for the week ending July 5 showed that fund managers reduced their net long positions in Comex gold futures by 7,378 to 103,472. At the same time, short positions increased by 11,690 to 86,438. Net long positions in gold are currently 17,034, down more than 52% from the previous week, the lowest in three years. As hedge funds increase their bearish bets on the market, bringing speculative positions close to neutral, sentiment in the gold market has deteriorated rapidly. However, the rising bearish sentiment in the market could be a signal of a surrender trend, and gold prices may be nearing the bottom.

Technical Forecast of Gold Price Trend

To date, gold has struggled to find acceptance below the $1700 level. Despite this, gold's inability to find any meaningful support suggests that the risk remains skewed to the downside. The recent selling pressure may be far from over.

Any attempt at a recovery is likely to meet resistance around $1725-$1726, followed by the $1734-$1735 level. Above this, a short-covering rally could push gold prices towards the $1749-$1752 supply zone.

A break below the overnight low, near the $1698-$1697 area, would be seen as a new trigger for bearish traders, making gold vulnerable. Gold prices could accelerate their decline towards the September 2021 low, approximately in the $1787-$1786 range. The downward trajectory could extend further to the 2021 low, near the $1677-$1676 area.