Gold: Initial Test of $2,000 Rejected, What’s Next?

Gold prices have corrected lower after surging above $2,000 per ounce for the first time in a year as Credit Suisse's (NYSE:CS) sale to UBS (NYSE:UBS) initially failed to ease investors' worries over the ongoing banking crisis.

The prices of the yellow metal rose up to 6.5% throughout the last week, in the face of a global banking crisis that ultimately resulted in the collapse of Silicon Valley Bank and the sale of Credit Suisse to bigger rival UBS. Meanwhile, market participants are also increasingly betting that the Federal Reserve may slow the pace of interest rate hikes amid the persisting banking crisis.

However, the failure to clear $2,000 on Monday has yielded more weakness on Tuesday for gold. As such, the bearish weekly candle is now developing, which could cause gold prices to further correct lower, especially if the risk environment continues to improve.

On the other hand, the continued strength could stretch to $2,070 - a level that hosts a key near-term resistance for gold.

What’s Driving Gold Prices Higher

Last week, gold jumped 6.5% in its sharpest gain since the coronavirus pandemic outbreak after the collapses of several major banks and growing concerns over the Swiss bank’s health.

“The longer uncertainty rolls on, with neither market fears being wholly calmed nor a full-blown systematic crisis unfolding, the higher gold prices should be able to trade,” said Marcus Garvey, head of metals strategy at Macquarie Group Ltd.

The global central banks took steps over the weekend to prevent the banking crisis from deteriorating further and restore stability to financial markets. In addition, the Swiss authorities orchestrated a takeover of Credit Suisse by rival UBS for $3.23 billion in a megamerger, which somewhat limited the sell-off in bank stocks, even though the overall sentiment was fragile.

“Despite banking regulators rushing to shore up market confidence, the uncertain macro backdrop continues to entice buying (in gold),” analysts at ANZ said in a note.

Since the collapse of Silicon Valley Bank (SVB), the event that triggered the current banking turmoil, gold has added more than $100 to its price as investors sought protection in the safe haven asset. Gold’s reputation as a hedge against currency deflation and a crisis commodity has provided investors with a sense of security among a chaotic macroeconomic environment.

It marks a sharp U-turn for gold prices, which lost significant value last month on expectations that the Fed would continue hiking interest rates aggressively to bring down inflation. But the course of recent events in the banking sector has notably reduced such bets, with investors now being divided on whether the U.S. central bank will follow up on its earlier intentions to keep raising rates in a bid to cool inflation.

The new environment bodes well for non-yielding gold as investors continue to raise their exposure to the market. In terms of tonnage, exchange-traded fund (ETF) holdings of the bullion hit the highest mark since April last week, according to Bloomberg reports.

All Eyes on Fed

The Fed’s policy meeting will conclude tomorrow with its outcome being “the most difficult to predict in years,” said Ole Hansen, head of commodities strategy at Saxo Bank. If the central bank policymakers opt for a more dovish approach while inflation remains elevated, it could propel gold to new highs.

According to consensus estimates, the Federal Reserve is expected to pick the “safest” route and raise rates by 25 basis points (bps) as the risk of a pause in hikes could cause inflation to start rising again.

Fed Chair Jerome Powell’s history of actions shows that he prefers the safest way to proceed forward and that is in line with market expectations. The options market data shows that around 80% of traders expect the central bank to deliver another quarter-percentage-point increase on Wednesday.

While the Fed would likely prefer to wait, it needs to maintain its credibility. The U.S. central bank lost a significant part of that credibility due to its reluctance to scrap its transitory inflation call. As such, any decision that could cause inflation to reaccelerate represents too great of a risk.

"We expect the Fed to hike by 25bps at this meeting, but the decision & outlook for any tightening depend on financial stability. Recent economic momentum & inflation have been overshadowed by banking system risks, sharply repricing the Fed’s path,” Bank of America (NYSE:BAC) analysts wrote in a note.

Meanwhile, other market watchers think that recent banking collapses have provided the Fed with enough reason to halt rate hikes, claiming that such a move would not hinder its fight against inflation.

Wells Fargo (NYSE:WFC) analysts expect the Fed to “briefly pause its tightening efforts to ensure the situation is under control.”

“In our view, the last thing the FOMC wants is more financial instability that threatens the banking system and forestalls any additional rate hikes down the road. But, neither a hike nor a pause would surprise us."

Goldman Sachs (NYSE:GS) also expects the Fed to pause rate hikes this week, citing “stress in the banking system.”

A halt in the battle against inflation through rate increases should not present much of a problem, Goldman adds, given that bringing inflation back to the desired 2% target is a medium-term goal. As such, “the FOMC can get back on track quickly if appropriate, and the banking stress could have disinflationary effects,” the banking giant said.

The Fed’s latest projections in December suggest the peak level of rates entering a 5% to 5.25% range, implying two additional rate hikes. However, the recent banking turmoil means that the Fed’s rate increase path has become substantially less certain than before the crisis.

Summary

Gold prices are moving lower this week after initially falling to clear the $2,000 resistance on growing concerns related to the health of the global banking system. In the meantime, investors will shift their focus toward Fed’s rate decision that is due on Wednesday. Apart from the rate decision, the central bank’s summary of economic estimates regarding future economic growth, unemployment rates, and inflation, will also come into the center of attention.

. . .

Shane Neagle is the EIC of The Tokenist. Check out The Tokenist’s free newsletter, Five Minute Finance, for weekly analysis of the biggest trends in finance and technology.