Gold eyeing record highs as inflation expectations heat up

• Gold closed at record highs on Friday but remains well below the intraday record hit in early December
• US market-based inflation expectations have increased recently, moving further away from the Fed’s 2% target
• Markets began adding to Federal Reserve rate cut bets late last week, seeing four in 2023 as the Traders will want to pencil in ISM services, nonfarm payrolls and a couple of appearances from Federal Reserve Chair Jerome Powell as the known events to keep an eye on – they loom as the most likely candidates to move US rates, the US dollar index and gold.

Gold looks like it’s considering a run towards the record highs hit in December after logging the highest close on record last Friday. With little visible technical resistance evident on the charts, whether it gets there will likely come down to what happens with the US dollar and bond yields over the coming days. 

While it was sitting comfortably above the $2000 per ounce level beforehand, the most notable thing about the explosive move was that it came out of nowhere, arriving despite a lack of movement in other markets. The daily candle was big and bullish, helping it close north of $2081, the peak hit in May 2023 that had acted as a roadblock to bullish advances on the prior three occasions.

Gold surge was sparked by weak US economic data

The thrust higher came after the February ISM manufacturing PMI survey was released, revealing activity levels declined at a sharper pace with readings on employment, inflation and new orders softening from a month earlier. US construction spending released at the same time as the PMI report also showed a decline in January, resulting in US two-year Treasury note yields

falling sharply, dragging on the US dollar. Both moves reflect that markets now see a greater risk of the Federal delivering four rate cuts this year rather than three as seen earlier in the week.

That likely contributed to gold’s surge but the moves in rates and FX were nowhere near as a large nor that significant in terms of key levels. It suggests there was probably another factor behind the sudden flurry of buying into the weekend.

Markets see higher US inflation ahead

One possible explanation is inflation expectations, at least those measured by markets, continue to increase and are moving further away from the Fed’s explicit 2% mandate.

This chart shows US inflation breakevens for one, two and five year terms. For those who have never come across the term, breakevens measure what markets see inflation averaging over the specified period. Right now, they are pushing higher, signalling a belief among market participants that price pressures will remain higher for longer than previously anticipated.

Source: Refinitiv

For an asset that derives its appeal as being a hedge against inflation, the drift higher in inflation expectations at a time when markets are moving to price in more rate cuts from the Fed may have been enough to spark gold’s sudden surge.

Gold provides something for everyone right now

When it comes to the charts, while Friday’s move was undeniably bullish, it really needs to extend further on Monday to build confidence that a retest of the record high above $2140 may be on the cards. I’m watching $2088.50 carefully. On Friday, that’s where the upward thrust stalled, mimicking similar price action to that seen in late December when another rally stalled. Unless it can clear and close above here, the risk-reward for going long at these levels is not overly appealing.

Here are a few of trade ideas to consider.

One is to short gold, with a stop above $2088.50, looking for a push towards former resistance at $2065.

For those looking for upside, you could buy a successful break of $2088.50, with a stop below the level, targeting a retest of the prior record highs set in early December. Alternatively, pullbacks towards $2065 offer an improved entry level for longs, allowing $2065 to be used for protection with stop-loss orders.

My near-term bias for US rates and dollar is towards the downside, providing conditions that gold would normally perform well in.

-- Written by David Scutt

Follow David on Twitter @scutty