By Omkar Godbole
Gold dropped 8% in November
Gold prices dropped 8% in November. The sell-off began after Trump's victory in the US Presidential Elections on November 9 boosted expectations that the President Elect would pursue expansionary fiscal policy as promised during the Presidential candidate.
There was no financial market instability as widely perceived by many. That cemented expectations of a Fed rate hike in December.
Markets priced-in steeper Fed rate hike path
Inflation expectations in the US (difference between the yield on the 10-year Treasury inflation protected note and the yield on the 10-year US Treasury yield) rose to a two-year high following Trump victory.
All of a sudden, the talk of multiple Fed rate hikes in 2017 gathered pace. Prior to US elections, most experts were betting on just one rate hike in 2017. However, after the Trump victory, the experts began calling for two or even three rate hikes.
Note that the Dec rate hike probability stood at 70% ahead of the elections, which suggests that a major part of the drop in the yellow metal after elections could be due to expectations of a steeper Fed rate hike path in 2017.
Sustained oil rally is negative for gold
The negative correlation may sound strange, still it is likely to work at least in the short-run. A classic textbook rule suggests that higher energy prices mean high inflation and increased demand for the yellow metal (as an inflation hedge).
But times have changed. We are operating in the 'New Normal', which says a sustained rally in oil means increased odds of the Fed and other major central banks achieving their 2% inflation target. This also means decreased odds of more monetary easing.
In the Fed's case, a sustained oil rally means a steeper rate hike path.
OPEC agreed to cut its output on Wednesday for the first time since 2008. In response, the oil prices rallied 9%. It is too early to say that oil will see a sustained rally above $50 as it remains to be seen whether the non-OPEC producers curb supplies or boost the output in response to higher prices. A rise in the non-OPEC supplies over the next few months would derail the oil rally.
Gold could rebound if Trump under delivers
Gold drop post Trump victory is a part of the 'Hope Trade'… Hope that Trump would walk the talk, deliver massive fiscal stimulus and the in response the Fed would hike rates at a pace faster than previously expected.
However, the hope trade would quickly reverse leading to a sharp recovery in gold, if Trump under delivers.
Fed is expected to hike rates in December and signal more than two rate hikes in 2017. The logic is if Fed could signal four rate hikes back in December 2015, it could easily signal more than two rates hikes given that President Elect Donald Trump is expected to pursue expansionary fiscal policy.
Another scenario in which gold could rally is -
The Fed keeps rates unchanged in December (very low probability) The Fed hikes rates in December, but the Dot Chart points to only one or two rate hikes in 2017 (high probability)
The second scenario appears likely as the dollar has already rallied sharply. Furthermore, there is always a risk that Trump could under deliver. The long duration yields have rallied sharply as well. Hence, the Fed could downplay the speculation of faster rate hikes in 2017.
Gold Technicals - Long-term descending trend line intact
Repeated failure at the descending trend line since July followed by a sell-off to $1170 in November suggests the metal has lost its shine and may extend the losses to $1100 levels. On the daily chart, a potential bullish price RSI divergence could help the metal revisit $1200-1220, where fresh offers are anticipated. Gold could rally to $1270 levels if the Fed downplays speculation of a stepper rate hike path and Trump under delivers.
On the other hand, the metal could drop like a rock to $1070 levels if the Fed signals four rate hikes in 2017 and Trump "walks the talk".
Omkar Godbole, Editor and Analyst, joined FXStreet after working for four years as research analyst in number of Indian brokerages. Omkar holds a Masters degree in Finance and is deeply immersed in tracking financial markets across the globe.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Business relationship disclosure: Omkar Godbole, Editor and Analyst, joined FXStreet after working for four years as research analyst in number of Indian brokerages. Omkar holds a Masters degree in Finance and is deeply immersed in tracking financial markets across the globe.