There will be upward pressure on US and global yields amid a sharp decline in net central bank purchases and the dollar is likely to start 2018 on a positive note. Despite short-term gains when equity markets correct lower, spot gold will be vulnerable to a slide to key support around $1,200 per ounce and potentially to 2017 lows of $1,130 per ounce during the first quarter of 2018.
Gold has remained under pressure this week with spot prices hitting fresh 4-month lows below $1,240 per ounce as the US 10-year yield has pushed back above 2.40%.
Amidst the focus on short-term interest rates, the Fed’s balance-sheet reduction plans continue to receive relatively little attention.
The Fed will, however, look to reduce the balance sheet by a further $10bn during December with net selling of $6bn in Treasuries and $4bn in mortgage-backed securities. For the first quarter of 2018, the targeted monthly decline in the balance sheet is set to double to $20bn with a further increase to $30bn for the third quarter.
The ECB will also cut its monthly purchases of bonds to EUR30bn in January from EUR60bn. At the beginning of 2018, therefore, the two most important global central banks will both be cutting bond-market support.
All other things being equal, the net shift in bond market demand/supply will put upward pressure on yields which will tend to sap support for gold.
Assuming the Federal Reserve sanctions a further increase in the fed funds rate to 1.25-1.50%, trends in short-term rates will also limit gold demand.
US tax-reform proposals will also be an important element with Congress aiming to get the reconciliation bill to President Trump by December 22nd. If legislation is signed into law this year, confidence in the 2018 growth outlook will strengthen further. Confidence in growth trends would tend to undermine gold demand and would also tend to put upward pressure on bond yields.
Higher yields and growth optimism are also likely to give the dollar a lift early in 2018 which will undermine gold support.
The latest CFTC data recorded a decline in long, non-commercial gold contracts, but the net long position was still over 170,000 contracts and compared with yearly lows around 60,000 in July. In this context, there is still scope for a shakeout in stale long positions.
The defensive qualities of gold will also be an important element of the equation. As global liquidity starts to tighten, equity markets will be at increasing risk of a sharp correction. Any sharp decline in equities would boost defensive gold demand and certainly help offset the underlying downward pressure on prices.
In view of stretched valuations of equities, a very sharp corrective decline in equities is certainly an important underlying risk factor.
Given the net selling pressures from a tighter monetary policy, however, the most likely outcome is that underlying downward pressure on gold would be punctuated by sharp, albeit temporary gains when equity markets spike lower.
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