Gold Enjoying Fragile Risk Mood Amid Tensions

Written on 24/02/2022 by Lukman Otunuga, Senior Research Analyst at FXTM

It seems there is no place like the yellow metal when it comes to times of stress and surging inflation. Nervous investors always need a safe place to deleverage and park cash when uncertainty is elevated.

The geopolitical crisis in Ukraine has provided the impetus for the advance, with many investors also believing that gold is benefitting from worries that US growth could slow, just as the Federal Reserve is forced to raise rates aggressively in order to tame the inflation beast. We get the latest data this Friday from the Fed’s favoured measure of price pressures in the form of the core PCE deflator. This is expected to top 38-year highs, following on from similarly historic CPI prints in January.

JP Morgan is the latest Wall Street investment bank to raise its forecast for interest rate hikes by the Fed this year. It believes that policymakers will now move rates nine times in consecutive meetings, starting next month. This is definitely a huge shift, from even just six months ago and the potential for an inflation-induced monetary policy error can only be increasing, which is music to the ears of gold bugs.

Interestingly, the relationship between gold and inflation-adjusted “real” interest rates has actually started to weaken amid concerns about the economic outlook and soaring prices. Typically, real rates are negatively correlated with gold as higher interest rates make non-interest bearing assets such as bullion less attractive. A relatively subdued dollar has also underpinned gold’s path to eight-month highs.

Of course, one of gold’s most attractive features is as a diversification hedge against the military conflict in Ukraine, with geopolitical tensions currently outweighing rising real yields. The precious metal has relatively low volatility, both from a correlation perspective and also on a realised basis. In which light, ETF flows have been increasing this year after falling in 2021. Speculative positioning is also relatively lean at present which has left room for investors to actively add fresh longs that has limited liquidation risk.

These clearly bullish signals for gold have seen it push up to long-term highs above $1900. But so far, a zone of resistance, which includes the prior June 2021 high and a major Fibonacci level of the large sell-off wave from the 2020 top to last year’s low, has proved a move too far. Consolidation is the name of the game for gold bugs, with important support at the November high at $1877.

Near-term, much will obviously depend on the ongoing Ukraine crisis with Western nations appearing to “keep their powder dry” regarding stronger sanctions. Perhaps there is an element too of geopolitical fatigue, with the tiering of measures fairly well-flagged. But any stronger advances by Russian troops should give another bid to safe haven assets. Policy errors by the Fed will linger too, if military escalation doesn’t come into play.

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