Market research FXTM: Outlook for Gold in Q1, 2019

December 5, 2018 10:12 am

Written by Jameel Ahmad, Global Head of Currency Strategy and Market Research at FXTM

Investors entered the last trading month of 2018 in a wary mood, navigating the effects of Brexit negotiations, trade wars and volatility in global stock markets. Overall sentiment is shadowed with concerns over a global slowdown stemming from China’s cooling economy. Even in the face of a stronger US Dollar and expanding American economy, Gold price benchmarks were sustained over the psychological level of $1200 for most of 2018, indicating investors weren’t quite willing to put all their eggs in one safe-haven basket. On the upside, President Donald Trump and President Xi Jinping have agreed to a 90-day ceasefire on imposing further trade tariffs, raising hopes of a de-escalation of tensions and less pressure on the gigantic Chinese economy.

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Two of Gold’s most important drivers originate in the US. The Federal Reserve’s hawkish interest rate policy is supportive of a broadly stronger Dollar and investor attraction towards US Treasuries. The central bank has been tightening monetary policy for most of the year, following through with quarterly interest rate hikes in the first nine months to keep inflation in check. Then the Federal Reserve made an unexpected U-turn. In comments to the media at the end of November following two months of losses on US stock exchanges, Federal Reserve Chairman Jerome Powell said the Federal Reserve is approaching the neutral rate, indicating fewer rate hikes in 2019. Market participants rushed to sell-off US Treasuries and Wall Street surged.

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As of December 2, Gold hovers around $1227 while investors mull the precise meaning of a more dovish tone from the Federal Reserve. Expectations remain strong for another rate hike in December, but the interest rate outlook for 2019 is not as clear. The neutral rate is a theoretical stance in which monetary policy is neither accommodative nor restrictive. To quote Dallas Fed President Robert S. Kaplan, deciding the neutral rate level is considered more of an art than a science, leaving market participants no wiser. It appears likely there won’t be as many as four rate hikes in 2019, possibly indicating less strength for the USD and lower yields for US bonds. Given the inverse correlation between Gold and the USD, the precious metal could keep holding on its own during the first quarter if the Fed decides to back off on a rate hike for this period, especially in the case of more volatility in fixed-income instruments.

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During the sell-offs on Wall Street in October and November, US investors sent a clear message to the Federal Reserve – the prospect of a restrictive monetary policy is not welcome. Higher borrowing costs are a big concern for Wall Street and other economic actors like consumers and businesses, aggravating the inflationary effects of trade tariffs on commodities and manufacturing. Steel and aluminum prices rose directly after the tit-for-tat import tariffs with China, affecting big ticket consumer items like vehicles and building materials for houses. The housing market is a historic weakness in the world’s largest economy and always bears careful watching for distress signals. Already, it’s being described as ‘tough’ because of higher mortgage rates and prices. A slowdown in the housing sector is likely to feed negative effects into the underlying economy and eventually the banking and mortgage sector.

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A hawkish US monetary policy and strong USD can also be described as ‘tough’ on emerging market economies like China and India, which are the world’s biggest consumers of Gold. Their currencies are no match for a stronger USD, meaning their Gold purchases are more expensive because they are on the losing side of the currency exchange. Demand for Gold during Diwali was at its lowest level in 10 years because of the weaker Indian Rupee, according to local reports.  Reduced demand for Gold from the Asian markets could persist into the first quarter if there is another US interest rate hike in December, possibly dragging on the precious metal’s price.

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In my opinion, the two most important factors for Gold in the first quarter are US monetary policy and expectations of global growth. Fed Chairman Powell said monetary policy is ‘near’ the neutral rate, meaning 2.75 percent is a candidate to be the neutral rate, indicating the next rate hike after December may be later in 2019 rather than sooner. In this scenario, Gold could appreciate amid uncertainty and a potentially weaker USD during the first quarter. If the Federal Reserve decides on three percent as the neutral rate, then two more hikes are on the horizon – one in December and one at the end of Q1. In this scenario, Gold may be capped at current levels due to the hawkish interest rate environment extending into 2019. Then again, the outlook for Gold could change towards the upside if there are more serious signs of a slowdown in China and contagion in the wider global economy, possibly increasing safe-haven buying and adding to Gold’s value in Q1.

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Jameel Ahmad is an expert in financial market developments, and specialises in global currencies, commodities and emerging markets. FXTM’s VP of Corporate Development and