The precipitous sell-off that transpired in gold prices on Tuesday is not just startling in terms of size and scope, but equally indicative that market participants are leaning towards one US rate hike before the end of the year.  On the heels of a substantial US dollar rally, gold had its worst session in 3-years, plunging by over 3.00% before finding bottom.  However, the losses may be far from over as evidenced by the disappointing bounce, with the rebound during Wednesday’s session falling flat at very best.  With investors increasingly lining up behind the idea of more normalization, these losses in gold might be just the beginning for prices as December approaches.  Considering the importance of Friday’s upcoming jobs report, more positive news for the US could very well spell the end of gold's 2016 rally and presage another downturn for the precious metal.

Fed Optimism Prevails

Even with the disagreement raging within the Federal Reserve about the timing of any interest rate increases, the split nature of the Central Bank indicates that change is coming, especially with policymakers failing to reach a unanimous decision during their last meeting.  Although the immediate aftermath of the decision saw a slew of dovish jawboning from Fed Presidents, this week has seen the reverse, with Cleveland Fed President Loretta Mester calling for higher rates.  While the likelihood of December action has retreated from higher probabilities reached earlier in the week, Fed Fund futures still indicate over a 50.00% probability of action, keeping a lid on gold prices in the meantime. Despite US economic conditions that could be described as tepid and uneven at best, among advanced economies, the US continues to outperform, making the prospect of December action on rates still very real.

While some market participants will point to the latest ADP nonfarm employment figures as proof that job creation is not overheating and that the economy is facing some speed bumps, this is still not enough to delay the inevitable.  Should Friday’s nonfarm payroll figure match or exceed or expectations, or manage to remain above 150,000 jobs added, the last remaining piece of the puzzle is inflation.  Even though many policymakers have asserted that they are unconcerned by inflation trending above the Federal Reserve’s longer-term 2.00% target for a significant period of time, the rapid ascent over the last 6-months indicate that the goal will be hit sooner rather than later.  Besides heightening speculation that action on rates may finally be prescient, the dollar has responded to shifting outlook, with the US dollar index near the highest levels since August, reducing the appeal of holding precious metals.

Technically Speaking

The indications have been clear for some time that gold prices were not headed significantly higher after prices were unable to overcome July highs that transpired after the British referendum outcome. Key resistance that sat at $1380 per troy ounce remains unbroken, with the precious metal forming lower highs in each subsequent upturn in prices. The result was a triangle consolidation that formed the basis for a descending triangle pattern.  After breaking cleanly through support at $1305 and crossing below the crucial $1300 psychological level, prices remain just marginally above longer-term support at $1250, indicating a clean breakout thanks to a candlestick close below support. However, stopping momentum lower its tracks is the 200-day moving average which neatly coincides with the $1260 level.  Should this key level be broken, however, it could pave the way back towards $1200 per troy ounce.

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Gold bugs might receive some temporary respite from their woes, especially when considering the ferocity of the recent losses.  The major oscillators including the Relative Strength Index and the Stochastic Oscillator are pointing to gold being oversold and potentially at a turning point that results in a moderate retracement of the most recent losses. However, the bounce may be taken as an opportunity to bearish traders to reestablish positions at higher levels, once more driving prices lower.  Ideally, those waiting for a bounce would await a 15-20 point-rebound before establishing positions to avoid selling the bottom in this particular case.  However, should rate hike expectations continue to rise on the back of better data which fuels gains in the US dollar, any correction higher would likely be short-lived.

Looking Ahead

Heightened rate hike expectations may just be one symptom of gold’s accelerating velocity lower.  A dollar shortage in Europe or a risk-off move that sees investor funds flow into the United States could also be forces that reduce demand for holding precious metals, especially if it coincides with a monetary tightening environment.  The key to any further momentum lies squarely with the data and how it evolves over the coming weeks leading up to the December rate decision. With a November move largely off the table due to appearing overtly political in nature, surprises from the data between now and then could spur aggressive buying or sell-offs in gold depending on how the cards should fall.  However, should the current trends in employment and inflation persist over the medium-term, at least one adjustment is assured before year end, lessening gold’s attractiveness.