Gold’s astounding rally and the challenges ahead

• Gold gains around 18% year-to-date.

• But is it time for the uptrend to cool down a bit?

• Even if so, the broader outlook remains positive.

Gold shines bright

Gold had a great year-to-date performance, gaining around 18% and hitting a record high of 2450 on May 20. As discussed in previous reports, gold’s uptrend was fueled by geopolitical uncertainty, continued central bank buying and strong consumer demand, especially in China, as well as expectations of lower borrowing costs, at least in most developed nations.

 

But will those forces remain intact? Will gold extend its prevailing uptrend without looking back, or has the momentum run out of steam?

Overly dovish Fed rate cut bets

After hitting a fresh record high on May 20 at around 2450, the precious metal pulled back to settle within the sideways range between 2290 and 2390, which contained most of the price action since the beginning of April. Perhaps this was due to the People’s Bank of China not purchasing any gold in May and June.

That said, just last week, the metal found its footing again and emerged above the upper bound of that range as the US CPI data revealed that inflation continued to cool in June. Coming on top of the soft employment data for the month, the CPI numbers cemented expectations of a September quarter-point cut by the Fed, with market participants increasing the basis points expected to be cut by the end of the year to 68. This translates into an around 70% chance for a third 25bps reduction before the turn of the year.

 

However, betting on a third rate cut this year may not be that realistic. After all, the Fed’s latest dot plot has pointed to just one, while Powell, although confident about the progress of inflation, stressed that they need more evidence before they consider starting to lower rates.

What’s more, following the assassination attempt on US Presidential candidate Trump, the chances of him returning to the oval office may have increased and a Trump presidency may not be rate-cut friendly as his pledges to lower corporate taxes and add tariffs on China could very well prove inflationary.

All in all, incoming data pointing to some stickiness in inflation or better-than-expected economic performance could allow the dollar to rebound, and thereby weigh on gold, as investors reconsider the chance of a third rate cut this year.

Slowing Chinese demand

Besides the pause in PBoC’s purchases and the upside risks in Fed rate cut expectations, what could also weigh on the precious metal’s momentum in the short term may be more progress in the Israel-Hamas ceasefire talks and the slowdown in retail demand in China.

In the absence of any other investment vehicle to profit from, during the last couple of years, Chinese retailers rushed into gold, and this was evident by the acceleration in Chinese prices compared to international prices. However, lately, international prices have been rising faster than the Shanghai benchmark prices, implying a slowdown in Chinese demand.

 

Any correction may be short-lived

Having said that though, any potential correction due to the aforementioned risks is likely to prove limited and short lived. As it was highlighted several times in previous reports, delayed rate cuts may not be much of a concern for gold investors as their horizons are likely longer than those of forex traders. The fact that the Fed is seen beginning an easing cycle soon may be more than enough as it keeps the upside potential in Treasury yields limited.

Moreover, the PBoC may reaccelerate its purchases over the next few months leading up to the US elections in November, as a Trump victory carries the risk of worsening US-China relations. Thus, Chinese policymakers may continue eliminating their dollar dependency to minimize the economic damage in case the US decides to weaponize its own currency.

As far as retail demand is concerned, with the Chinese stock market pulling back again lately and cryptos banned in the world’s second largest economy, many investors may soon decide to return to the precious metal.

A still-bullish technical picture

From a technical perspective, gold reclaimed its shine after the lower-than-expected US CPI data, breaking above the key resistance (now turned into support) barrier of $2,390.

 

Now, the metal seems to be headed towards its all-time high of $2,450, but even if the bulls overtake that zone soon, a retreat could still be possible. After all this was the case during the last couple of times the metal hit records. Having said all that though, any retreat could stay limited above the key area of $2,390, from where the bulls may jump back into the action.