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Where Next for Gold After it Comfortably Breaks Through $1,400?

Over the past week, a dovish Fed and renewed tensions in the Middle East have sent the gold price comfortably above the psychologically important $1,400 level (touching $1,439 on the 25th as we write), a level last revisited more than six years ago. While Metals Focus expects further upside, we would caution that near-term headwinds still exist.

Even so, the prospects for the gold price appear bright, with gold likely to continue strengthening over the medium term, notes Charles de Meester in the Precious Metals Weekly, a newsletter published by Metals Focus, one of the world’s leading precious metals consultancies.

Returning to the current backdrop, most important of the challenges that gold may have to contend with, remains the likelihood of a partial recovery in the dollar in the near term. This in turn reflects three issues. First, while the Fed strongly hinted the possibility of interest rate cuts (after its June FOMC meeting), the ECB’s latest meeting also signals a yet more dovish policy stance.

The latter could result in interest rates moving deeper into negative territory in the Eurozone, and also see the ECB resume asset purchases. Staying with Europe, either candidate in the UK government’s leadership contest has arguably boosted the chances of a no-deal Brexit (as the end-October deadline looms to leave the EU); all of which is likely to weigh on the euro.

Second, the outlook of the China-US trade negotiation is, at best, uncertain. Although further talks are planned for the late June G-20 meeting, the US has already signalled that, should these fail, President Trump will have the “legal authority” to raise tariffs on a further $300bn of Chinese goods by as much as 25%, which ultimately will weigh on the global economy.

Against the backdrop of an increasingly fragile macro environment, emerging markets (EMs) currencies (and equities) will be the biggest casualties, a scenario which played out in late 2018/early 2019. Back then, in the wake of escalating China-US trade tensions, investors shifted in favour of the greenback at the expense of EM currencies.

In spite of a marked shift in the Fed’s policy stance in recent months, we believe that market expectations of how far they will cut rates have become overly dovish. At present, implied probabilities from Fed fund futures suggest a rate cut as early as July, with another 1-2 cuts likely before end-2019.

While it appears almost certain that US interest rates will end 2019 lower, we believe that investors will be disappointed as the Fed ultimately adopts a more patient approach than currently envisaged. This in turn should be dollar positive, which is likely to create a short-term headwind for the gold price.

Leaving aside a potential recovery in the dollar, we would caution that the boost from worries about a potential US military strike against Iran will be difficult to sustain. As geopolitical risk premiums quickly unwinds, demand for safe haven assets are likely to dissipate.

For now though, professional investors have undoubtedly lifted their exposure to gold. In particular, Comex managed money long positions (reported by the CFTC) are at their highest since this March (of 17.0Moz), with gross shorts their lowest since April (at 4.0Moz), taking the net long up to 12.9Moz. These relate to positioning as of 11th June (the latest available data), and so does not capture investor activity during gold’s charge towards $1,440. As a result, we would expect to see Comex positioning strengthen further, although importantly we do not believe it will eclipse the July 2016 record of 27.3Moz.

As such, this will leave considerable room for investor positioning to start to grow further later this year, when we believe conditions will begin to turn decisively more supportive of a higher gold price. In particular, as the US economy loses momentum (the impact of the 2018 tax cuts fade and the trade wars start to bite), this will feed through into a sharper drop in equities.

Elsewhere, many of the tail-risks that have been in place in recent years, that might encourage defensive investments, still remain relevant. These in turn should encourage a pronounced jump in safe haven demand, for a range of assets including precious metals. As such, we expect gold to set new highs before year-end, with these gains extending into 2020.

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