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Metals shaping up to move on key Fed decision

Fri, 07/29/2022 - 22:34

Initially tipped to shoot to the sky in the wake of the 2020 pandemic, gold and silver have, in fact, been trapped in a sideways market for the past two years. At its current price of $1,721, the yellow metal is actually below its 7 August 2020 peak of $1,743. It's a similar story for silver, too, which is now at a long-term low of $18.60. However, the tide could well be about to turn as the Fed raises rates yet another 75 basis points. But what is behind precious metals' failure to launch after their early 2022 rally, and how should traders position themselves in this crucial asset class?

Rising T-note yields

Amid double-digit inflation following huge pandemic-era stimulus measures, central banks everywhere were forced to act in order to bring price pressure under control. Aggravated further by supply chain issues, the consumer prices of many household staples rose by over 20% in the space of just a few months, and action simply had to be taken.

The US Federal Reserve has perhaps been the most aggressive in its policy, raising rates by almost 2% in three separate increases since January of this year. Unsurprisingly, this has led to significant rises in US Treasury bond yields, with both the 2- and 10-year notes now offering yields above 3%. Given gold and silver's primary role as stores of value or 'safe-haven' assets, these attractive rates of return in the more liquid bond market have naturally stifled demand for precious metals.

Strong dollar

Another inevitable effect of the Fed's rate hikes has been a stronger US dollar, with the fibre (EUR/USD) recently reaching parity for the first time in over two decades. Again, fiat is obviously a much more liquid instrument than physical metals, and this has led many investors to prefer cash over gold or silver recently. While good news for holders of USD looking to trade with Europe or China, an exceptionally strong dollar is terrible for US exports. The US regulator has now made its second consecutive 75-basis-point hike, bringing its funds rate into the 2.25-2.50% target range. With the ECB still reluctant to go fully hawkish, the greenback will only continue to strengthen against the other world majors unless the Fed puts its plans for a 3%+ funds rate by 2023 on hold.

Watch out for a recession

While typically not something traders look to with optimism, the brewing global recession is likely to be the catalyst precious metals need to break out of their sideways channel and reach new heights. The consensus is that the Fed will be forced to take a breather from its ambitious rate hike programme in order to dampen the coming recession and that this will enable gold and silver to pick up the slack as a hedge against volatility and inflation. The Eurozone's poor consumer confidence and PMI figures are well known following its months-long energy crisis, but now the S&P Global US Composite PMI has fallen to 47.5 from 52.3 in June, while the services index is down to 47 from 52.7.

This has led the White House to suggest we ought to rethink the definition of a recession as two consecutive quarters of negative growth, but declining real yields and falling exports are fairly damning by themselves. As always, what's bad for business tends to be good for gold, so why should expect this time to be any different?

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