Gold: Don’t Ignore Inflation Risks. Quarterly analytical reviews by AMarkets

Gold: Don’t Ignore Inflation Risks

The 4th quarter of 2021 is shaping up pretty well for gold bulls. Gold prices rose 1.5%, approaching the psychological resistance of $1800 per troy ounce.

Back in September, traders tried to keep off the precious metals market, anticipating its further collapse amid the strengthening dollar and rising US treasury yields. Nevertheless, the situation has changed. The 10-year US Treasury yields failed to hold above the 1.6% mark and dipped, allowing dollar bears to take advantage of this sell-off and return to the market.

It’s worth recalling that a rise in government bond yields reduces interest in gold, which does not yield a fixed return. Stronger dollar makes assets denominated in the USD more expensive for holders of other currencies. And vice versa: when the dollar weakens and the 10-year U.S. Treasury yields renew their local minimums, gold demand increases.

Rising inflation provides additional support to gold. According to the latest data from the US Department of Labor, the consumer price index rose 0.4% in September after climbing 0.3% in August. On a year-over-year basis, prices increased 5.4%, while economists estimated a 5.3% increase on the back of growing oil prices and persisting supply chain problems.

Figure 1. United States inflation rate MoM. October 2020 to September 2021. Source: tradingeconomics.com.

 
Today, inflation in the United States is significantly higher than the yield on US 10-year Treasury notes. It means that the real yield on US Treasury bonds is negative. Take a look at the graph below. The brown line represents the current inflation rate, and the blue line shows the current Treasury yield.


Figure 2.The spread between 10-Year Treasury Constant Maturity and inflation (Consumer price index) for the period from March 2018 to September 2021. Source:
fred.stlouisfed.org

 
Since gold rises in value as the real yield falls, i.e., as the spread between 10-year Treasury yield and inflation widens, it’s not surprising that this precious metal has attracted strong buying interest in recent weeks.

Experts believe that gold is yet to hit its new highs this year as rising oil prices, logistics problems, the economies’ reopening and consumer activity recovery due to the deferred demand will continue to exert upward pressure on inflation.

That being said, long XAU/USD positions in the range of $1730-1750 with growth targets around $2000 look quite promising.

BuyLimit $17301750 TP $2000 SL $1680


Figure 3. Gold (XAU/USD) dynamics in the period from January to October 2021, in US dollars.

 

Dollar becomes an outsider

The US Dollar Index (DXY) fell below 94.00 points at the beginning of October after buyers made a failed attempt to gain a foothold above the 94.50 mark and the initiative quickly passed to the sellers.

Strangely, investors completely ignored both the latest US inflation data and minutes of the September Federal Open Market Committee (FOMC) meeting, which confirmed the Fed’s intention to start tapering its quantitative easing (QE) program as soon as possible. In particular, according to minutes from the September meeting, half of the voting members supported a plan to slow $120 billion in monthly Treasury bond and mortgage-backed security purchases at the next meeting in November.

Note: The Fed’s asset purchase program (also referred to as QE) has been a key component of the Fed’s stimulus policy to limit the economic damage from the global coronavirus pandemic.

Traders are reluctant to buy the dollar in the current environment, probably due to the assumptions that when making its decision regarding the tapering, the Fed will be guided not by the dynamics of the consumer price index but by the state of the national labor market. And this sector of the US economy seems to be lagging behind.

After US employers added 366 thousand new jobs in August, analysts forecasted that the situation would improve in September. However, the jobs creation data turned out to be a huge disappointment again. Instead of the expected 500 thousand, the US economy created only 194 thousand new jobs, one of the worst indicators since the beginning of the pandemic.


Figure 4. US Nonfarm payrolls in the period from October 2020 to September 2021. Source: tradingeconomics.com

 
The modest employment figures may well force the Fed to postpone its tapering decision until the 1st quarter of 2022. Until it happens, the dollar won’t be able to resume its bullish trend. The likelihood of such a scenario will increase significantly if October Nonfarm Payrolls also disappoint.

The unresolved US debt ceiling issue will continue weighing on the greenback. Earlier, US lawmakers approved a measure to increase the federal debt limit by $480 billion. But it’s a temporary fix that will last only until December 3. If Congress fails to pass legislation to fund the government until the specified time, the United States risks going into default.

Republicans made it clear that they will not support Democrats in raising the debt limit after December 3, urging the current US administration to reduce government spending or take other measures to reduce debt. Thus, in a month, the market may face another period of increased volatility. The inability of the Treasury Department to pay debts will undermine the dollar’s status as a reserve currency.

Against that uncertain backdrop, US President Joe Biden has yet to decide whether or not to nominate Federal Reserve chairman Jerome Powell for a second term, which is another negative factor for the dollar. While Powell remains the leading candidate for the position, recent scrutiny over the trading activity of two leading regional Federal Reserve officials that resulted in their resignation clearly casts a shadow on Powell’s future.

Considering the above, the US Dollar Index (DXY) maintains the downside potential in the 4th quarter and may well test the 92.00 support.

DXY SellLimit 94.20 TP 92.00 SL 94.60


Figure 5. US dollar index (DXY) in the period from July 2020 to October 2021.

 

The global energy crisis and its impact on oil

Oil prices keep hitting their multi-year highs. The bullish dynamics has been observed for the past two months. In October 2021, WTI rose to its highest since 2014 and has all chances to climb even higher.

The global energy crisis caused a sharp rise in Brent and WTI crude oil. An acute shortage of natural gas, liquefied natural gas (LNG) and coal amid the global economic recovery has triggered an unprecedented rise in the corresponding commodity assets, prompting power plants and electricity providers to switch to oil products and direct crude use for power generation.

 


Figure 6, 7. Natural gas and coal quotes in the period from January 2016 to October 2021.

 
Against this backdrop, the International Energy Agency (IEA) revised up its 2021 and 2022 global oil demand forecast by 170 thousand and 210 thousand barrels per day, respectively. The IEA noted that the global energy crunch is expected to boost oil demand by 500,000 barrels per day. And taking into account further recovery of the global economy from the COVID-19 pandemic and the upcoming winter heating season, the oil demand will rise even more.

The situation is aggravated by the fact that capital investments in oil production, coal, nuclear energy and other sources of energy have dwindled after the 2014-16/2020 collapse in oil prices while investments in alternative energy are not enough to build the sufficient amount of wind and solar farms to meet growing energy demand. As a result, the global shortage of hydrocarbons is increasing.

Figure 8. Global energy investment,  2017-2021, billion USD. Source: iea.org

 
The oil recovery scenario is also supported by expectations that the energy crisis in the Northern Hemisphere is not going to go away anytime soon and that the OPEC+ alliance won’t boost oil production beyond the previously agreed volumes. In other words, the cartel will stick to its existing deal to gradually increase oil production by 400000 barrels per day each month, which, according to many experts, is not enough to cover the global demand.

Market participants believe that if OPEC maintains current output levels, the oil supply deficit in the fourth quarter of 2021 may exceed 1 million barrels per day. With that said, it’s time to recall the forecast of Citigroup Inc. experts who said WTI might hit $90 a barrel.

WTI BuyLimit $80.00 TP $90.00 SL $76.00


Figure 9. WTI crude oil in February-October 2021, in US dollars.

 

BITO and new Bitcoin era

Bitcoin has good chances to update its historical maximum and reach $65 000 in the 4th quarter of 2021.

What are such optimistic predictions based on? First of all, Bitcoin keeps being in demand as a reserve asset, which allows investors to protect their capital from the sharp rise in inflation observed throughout the world. Second, BTC buyers got another reason to rejoice – the long-awaited approval of bitcoin futures ETFs by the US Securities and Exchange Commission (SEC).

ETFs (Exchange-Traded Funds) are investment funds that form asset portfolios and issue their own shares, where each security is linked to a certain part of the underlying asset. ETFs allow you to purchase an asset without actually owning it.

In the case of the ProShares Bitcoin Strategy ETF, the fund is linked to bitcoin futures that have been trading on the Chicago Mercantile Exchange since 2017. Here, we are talking about the creation of a new safe instrument for entering the cryptocurrency market for institutional investors. The only thing we don’t know yet is how much money will be invested in bitcoin in the near future.

So, the first bitcoin-linked exchange-traded fund listed in the United States, the ProShares Bitcoin Strategy ETF, trading under the ticker BITO, became available on the New York Stock Exchange on 19 October. This date went down in history, especially considering that Bitcoin ETF applications have been filed since 2013, but each time they were rejected. Now everyone has the opportunity to invest in bitcoin and earn with it, bypassing largely unregulated and susceptible to fraud cryptocurrency exchanges.

Immediately after the listing, BITO rose 5%, recovering from $40 to $42. In the first 20 minutes, BITO’s trading volume exceeded $280 million. For reference, the SPDR S&P 500 ETF Trust (one of the world’s most popular funds that aims to track the S&P 500 index) debuted in 1993 and traded about $40 million on the first day. By the end of the trading session, BITO’s trading volume reached $984 million, which made it the second-most heavily traded new ETF on record after the BlackRock giant.


Figure 10. Most-heavily traded exchange-traded funds (ETFs) with the highest trading volumes on the first day of trading.

 
The hype around Bitcoin ETFs clearly demonstrates the desire of an entirely new class of investors to experience the benefits of investing in cryptocurrency as a legitimate asset. Many experts note that the launch of a fully legitimate bitcoin derivative demonstrates not only a special attitude of regulators to the cryptocurrency environment but also their readiness to move on towards creating a regulated spot market. In other words, bitcoin is going to stay with us for a long time. 

That being said, we have all the grounds to expect the BTC growth to $75 000. And given that it’s already trading at $65 000 per token, this scenario does not seem that unrealistic anymore.

BTC/USD BuyStop 66 000 TP 75000 SL 62 000


Figure 11. Bitcoin (BTC) dynamics in the period from February to October 2021, in US dollars.

 

S&P 500 keeps rising to new peaks

Investor risk appetite has been expanding throughout October, causing the US stock market to rally. The S&P 500 index recovered to 4500 points and was once again one step away from hitting its next all-time high.

Recently, bulls have received support from strong corporate earnings. Of the 10% of companies that have already reported their quarterly earnings, every four out of five exceeded experts’ expectations. Thus, labor shortages, supply chain issues, high inflation, as well as rising oil prices didn’t have a significant effect on corporate profits, which certainly reassured investors.

Growing doubts that the Fed will come through with its policy tightening support bullish sentiment for S&P 500. Following weak labor market data, the US also published disappointing data on US industrial output. According to the data released in October, industrial production in the United States fell 1.3 percent in September 2021, missing market expectations of 0.2 percent growth.


Figure 12.U.S. industrial production growth (MoM) in the period from November 2016 to October 2021.

 
Experts note that weakness in the industrial sector was caused by supply-chain disruptions and rising energy prices in Europe and Asia. Since these issues haven’t been resolved yet, we may keep observing the negative dynamics in this sector of the US economy at least until the end of this year.

According to a Reuters poll, 40 of 67 economists said the fed funds rate would rise from its current level of 0-0.25% in 2023 or later. Given the disappointing statistical data, the Federal Reserve will probably wait until 2023 before raising interest rates. It’s worth noting that a month ago, most experts betted on the rate hike at the end of next year.

Considering 2020 and most of the current year, we can see how low Federal Reserve rates affect the national stock market – during this period, the S&P 500 index rang up more than 100 record highs.

Traders’ sentiment could be dampened by the potential bankruptcy of China’s largest property developer, Evergrande, which accumulated $300 billion in debt or the US debt ceiling crisis. But Evergrande will probably be aided by the Chinese authorities, while the US debt limit issue has been temporarily resolved until early December.

That being said, if the news backdrop remains unchanged, the S&P 500 index may target the 4700 area.

S&P500 BuyLimit 4300 TP 4700 SL 4200


Figure 13. Dynamics of the S&P 500 index in the period from August to October 2021, in US dollars.

 

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