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Is It Time to Buy Gold? Bull Case vs. Bear Case

December 06, 2023

Last Friday, active month gold futures, which simply means the contract with the most volume/open interest (usually expiring within three months), closed at an all-time high of $2,091.70/oz., a comfortable $16/oz. break above the prior all-time record close of $2,075.20/oz. registered on August 6, 2020. However, the breakout to new highs occurred as the active month futures contract was rolling forward from the December 2023 contract to the February 2024 contract (secure storage costs result in higher back month futures prices).

Did Gold Breakout or Not? Typically, a futures contract roll would barely be worth mentioning, but at the end of November, the premium of the February contract over the December contract topped $20/oz., which is more than the $16/oz. breakout beyond the 2020 highs. Put another way, without the extra $20/oz. storage costs built into the February gold contract, gold would have closed Friday below the 2020 highs. That left many traders asking the question, “Did gold breakout?”

The volatility has resulted in gold becoming a popular investment topic this week and likely a source of many client questions, given the wide price swings. As such, we wanted to break down the latest developments in the gold market, explain some nuances between physical and futures markets and lay out the bull vs. bear cases for gold.

New Highs are New Highs: First things first, whether the new highs in the now front month February gold futures contract should be viewed as a legitimate bullish “new high” can be debated, and there is good support for both arguments. What cannot be debated is the price of spot gold (the over-the-counter price). On Monday, spot gold hit $2,071.95/oz., a meaningful break above the previous closing high of $2,048.15/oz. from August 5, 2020. So, regardless of the futures market valuation debate, gold hit new highs.

Market Influences on Gold: From a financial market standpoint, there are just three major influences on the price of gold. They are inflation (positive correlation; gold rises as inflation expectations rise), real interest rates (inverse correlation; gold rises as real rates fall), and the strength of the dollar (inverse correlation; gold falls as the dollar strengthens). Of those three influences, two are decidedly bearish, with the dollar in a long-term uptrend and real interest rates decidedly positive, while inflation expectations have been anchored near 2% for much of 2023, leaving inflation a neutral influence on gold.

Markets are of course, forward-looking discount mechanisms, so there is indeed a bullish case to be made for gold here to match the technical dynamics. Bullish Gold Scenario: Gold bulls are anticipating a massive dovish shift in monetary policy that will bring the fed funds rate down rapidly, to below the level of inflation resulting in real rates falling into negative territory again. The accommodative policy stance would also result in a weaker dollar and the potential for upward inflation pressures (again) supporting higher gold prices quarters ahead.

Potential Upside Target: On the weekly charts, the new highs elected a measured move out of the post-pandemic trading range that saw a peak of $2,046/oz. in the late summer 2020 and a trough of $1,648 in the fall 2022. Adding that 398-point difference on top of the previous high gives us a target of $2,444/oz.

Bearish Gold Scenario: Gold bears believe the Fed’s higher-for-longer mantra and anticipate that real rates will remain elevated and well into positive territory, pushing inflation back down to below trend while the dollar will remain in the long-term uptrend for some time, remaining a headwind on gold. Likely Downside Target: Analyzing the long-term trends, gold has a tendency to steadily retrace significant trough-to-peak rallies by roughly 50%. Using history as a guide suggests a pullback towards $1,825-$1,875/oz. as a logical downside target if the bears are correct.

Bottom Line: Gold hitting all-time highs is bullish from a technical standpoint but fundamentals are mixed as inflation expectations are largely neutral with 5-Yr break evens anchored at just over 2% while the recent pullback in real interest rates and the dollar are only modest relative to the scope of the long-term trends. Otherwise, the early December breakout in gold is likely to wind up being a “trap” for the bulls. Meaning, I don’t believe that gold is destined to be a great investment going forward. 

Sorry for all the technical language, but I wanted to give you the science behind gold movement. Suffice it to say you will make more money over the next 5 years on stocks than you will on gold. Gold is at a high for the past 5 years so would be a great sell right now.  

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