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On back of stubbornly high inflation as seen since the end of 2021 and exacerbated by yesterday’s hotter than expected August CPI numbers (+0.1% m/m vs consensus for a decline of -0.1% m/m, annualized CPI clocked in at +8.3% y/y vs consensus initially calling for +8.1% y/y, while lastly Core CPI was also higher than expected at +0.6% m/m vs consensus calling for +0.4% m/m ), Wall Street yesterday experienced one of its worst selloffs since June 2020. That said, when the dust settled, the S&P posted its fifth largest point loss, while the Dow posted it’s seventh largest point loss in history. All of this negative sentiment was a response to increasing expectations for an even more aggressive Fed – the thinking now seems to be that slaying inflation might just require an actual recession.
Despite all of this volatility, we note that the quintessential risk-off trade, - that being physical gold, has largely traded lower this year (a loss of nearly 8.0% YTD). What is even more telling is that after reaching an intra-day high of $2,040/ounce in early March, physical gold (GC=F) has since retreated by 16% to reach the current $1,709/ounce.
Though market consensus does seem to acknowledge how gold is deemed to be undervalued, certain historic correlations remain solid as ever, which would indicate further gold weakness in the near term. When looking at correlations since 2015, the negative correlations to rates have been confirmed at -0.64 and -0.66 versus yields on the 10 and 30 year treasuries. Gold’s correlations the general market seems to have increased given the +0.80 correlation to the S&P 500 while the historically inverse correlation to the dollar seems to have lifted given the +0.07 correlation to the USD since the beginning of 2015.
That said, given consensus expectations for rate increases extending until early 2023 (at least), coupled with increasing talk of a worldwide economic slowdown (possibly even a recession), the outlook for gold will likely remain negative for the near term. Despite the shorter term weakening correlation to the dollar, the LT historically negative relationship persists. Note that in light of all the Fed’s hiking (and expectations for many more increases), the DXY at 109.60 is nearing a 20-year high. Though Russia’s invasion of Ukraine has exacerbated inflation, only a largescale escalation (which is unlikely) will at this point provide an uplift to the precious metal. The case of increased inflation aiding gold’s appeal should help, however there are better inflationary hedges out there (derivatives or other instruments put together to closely hedge against CPI). Regardless, that inflation factor alone will not outweigh the combined factors mentioned above providing continued pressure on the precious metal. Its hard to be positive right now.