After tracking the previous four Fed tightening cycles, analysts at HSBC have determined that gold prices have rallied for at least 100 trading days after the first hike by the FOMC, and they think this time the rally could last longer. James Steel gives three reasons why the current rally in gold may be prolonged this time in his March 17 research note titled "Gold and the Fed."
Gold shines when Fed tightening cycles get underway
Steel points out that after 12 consecutive years of positive performance, gold prices posted their first year of losses in 2013. He notes that bullion prices collapsed by over $100/oz. over a two-day time span after entering a bear market in April 2013. He points out that, sensing a shift in Fed policy, investors started liquidating bullion in earnest.
The HSBC analyst argues that Fed policy perception played a key role in the selloff. For instance, more gold selling happened in May and June 2013 when expectations of a Fed tapering of its QE program led to rising real interest rates and falling inflation expectations. He highlights that the market remained on a downswing up to December 2015 when gold prices plummeted to a cycle low of $1,045/oz.
However, Steel points out that gold prices started resuming their upward journey this year. He believes tightening Fed policies don't necessarily imply the end of the current rally though. By looking at the previous four Fed tightening cycles that have happened over the past 30 years, the analyst points out that the USD dropped in the period immediately after the first rate rise.
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On the contrary, Steel points out that gold prices tend to rally as Fed tightening cycles get underway. He highlights that they weaken going into a tightening cycle and then rally for the next 100 trading days. However, the analyst believes that considering that rate hike expectations continue to be pushed into the future, the present gold rally will last even longer:
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Gold prices: current rally has more room to run
Even though gold rallied by over $200/oz. or by over 20% since hitting cycle lows in December 2015, Steel argues that unlike in the past, this time one can anticipate the rally to be extended. The analyst pegs his top-end forecast for gold at $1,300/oz. this year.
He alludes to three reasons for his bullish view on gold. First, highlighting a dovish FOMC view, the analyst points out that last week's scaling back by the FOMC of its forecasts for lifting interest rates later this year triggered a gold rally and that the ratcheting down of rate hike expectations to two 25bp increases from four previously are likely to keep the market buoyant.
Second, the HSBC analyst anticipates that the USD will weaken, facilitating firmer gold prices. He points out that the U.S. Fed has revised its rate projections lower, while the ECB and Bank of Japan are no longer chasing their currencies lower. Steel points out that his firm's FX research team continues to expect the EUR-USD to finish the year at 1.20, thereby supporting his bullish view on gold.
Highlighting the third pillar of support for gold, Steel underscores the global phenomenon of negative interest rates. He believes that with an increasing number of central banks implementing a negative rates policy, and this reflecting continued economic weakness, gold will get support by this backdrop. The HSBC analyst points out that gold may be a better alternative to cash in some cases as it doesn't carry the risk of central bank intervention by a monetary authority wishing to limit its currency's appreciation.