Gold Prices up to 3-Month High

Last Friday, gold finished trading with its best weekly gain in seven months. The precious metal went on to reach its highest level since the beginning of November 2016 on Monday, as market participants reduced their bets on rate hikes in the near future.

Last Friday, the first NFP report of the year showed that far more jobs were created in January than previously thought (227,000 as opposed to 170,000), while the unemployment rate increased slightly to 4.8%. The report also indicated weaker wage growth, suggesting a lack of inflationary pressures.

Gradual rate hikes to be expected

Last week, the FOMC decided to leave its monetary policy unchanged, with the federal funds rate staying within the 0.50 - 0.75% range. Federal Reserve Board members noted that investors should expect “gradual increases in the federal funds rate,” which should stay low “in the long run.”

Chicago Federal Reserve Bank President and CEO, Charles L. Evans, delivered a very dovish speech last week. He said: “I believe that appropriate policy calls for a slow pace of normalization in order to give the real economy an adequate growth buffer to withstand downside shocks that might otherwise drive us back to the zero-lower-bound.”

After raising rates for the first time in 10 years in December 2015, the Fed had anticipated four rate increases in 2016. However, global economic and political uncertainty, combined with high market volatility, have caused sufficient uncertainty for the Fed to reconsider.

With minimal wage inflation across the USA, and uncertainty about the new administration’s decisions on growth, employment, and inflation, the next rate hike might not be imminent. In December, however, FOMC members announced that rates would likely rise three times in 2017.

Weak wage inflation

The Fed has a dual mandate of full employment (employment rate target = 4.8%) and price stability (PCE index target = 2%). The last employment report was positive, but the weak point was wage growth, which is closely monitored by investors to predict future  decisions by the Fed.

Uncertainty surrounding future interest rates rises is increasing, as is doubt about the overall impact of fiscal stimulus policies. Such anxieties only serve to drive investors towards safe-haven assets, boosting the price of precious metals.

One reason for this is that all decisions made by a central bank influence the cost and availability of the money in the economy, directly impacting currency supply and demand in the foreign exchange market. Commodity prices and the USD have a negative correlation: when the USD goes up, commodity prices tend to go down, and vice versa.

When a country’s interest rate rises, this attracts foreign investors, as demand for the national currency increases relative to other currencies. Higher interest rates also increase borrowing costs, reducing the amount of money in the markets, boosting further the value of the relevant currency.

When investors are unsure when subsequent rate hikes will occur, the value of the US Dollar tends to fall, which drives commodity prices upward.  This process happens independently of the fundamental factors driving supply and demand.

Gold is a safe-haven asset usually bought in times of high market volatility and economic uncertainty. It’s worth noting, however, that in the past, when Gold and bond yields have increased in value at the same time, the markets were on the verge of a major correction. This is certainly something to watch out for as you plan your gold trading positions.