Can Gold Build On Its Impressive Gains?

Gold staged a powerful rebound last week, gaining almost 7.5% after spending several weeks trapped in a relatively tight range around the $4,000 mark. The scale of the move has brought the metal back into focus, but the more important question is whether this marks the beginning of another sustained advance or simply a sharp counter-trend rally within a broader period of consolidation. I remain sceptical.

CPI now takes centre stage

The dollar has four major hurdles to clear before the 16 September FOMC meeting: another employment report, two inflation releases and the Jackson Hole symposium.

The importance of each will depend on how they alter expectations for Fed policy. If incoming data continue to support the case for no policy change, markets could further reduce their bets on a September rate hike, putting further pressure on the dollar and potentially providing another tailwind for gold.

However, a sufficiently strong run of data could quickly reverse that dynamic, leaving plenty of scope for markets to reprice tighter policy again.

The next major test comes on Wednesday with the release of July’s US CPI figures. This report could prove particularly important given Fed Chair Kevin Warsh’s emphasis on keeping inflation under control following years of policy missteps.

Economists expect headline CPI to rise 0.1% month-on-month, taking the annual rate to 3.4%. Core CPI is forecast to increase 0.2% on the month, leaving annual core inflation at 2.5%.

Inflation could still complicate the gold story

A softer-than-expected CPI print would strengthen the argument for a more dovish Fed and could push spot gold prices higher. But the risk is not one-way. Oil prices remain elevated, keeping the threat of renewed inflationary pressure firmly in view. A hotter-than-expected CPI reading could therefore produce a sharp reversal in rate expectations, lifting Treasury yields and the dollar while putting some of the recent gains in gold at risk.

Markets are currently pricing only around 11 basis points of hike for the meeting, meaning there is considerable room for a hawkish repricing. With no major US economic releases scheduled for today, markets are likely to consolidate ahead of Wednesday’s inflation data. The dollar could regain some lost ground, which could put some renewed pressure on gold.

Weak payrolls put the dollar under pressure

The catalyst for the latest rally in both gold and silver prices (see the latest silver price chart) was Friday’s US employment report, which delivered another distinctly negative signal for the dollar. Headline payrolls fell by 20,000, but the weakness ran considerably deeper once previous data revisions were taken into account. More than 100,000 jobs were wiped from earlier estimates, leaving average payroll growth over the past three months at only around 20,000. The decline in the unemployment rate, meanwhile, was less encouraging than the headline figure suggested, with labour-force participation falling as people exited the workforce.

Taken together, the report reinforced expectations that the US labour market is losing momentum, increasing pressure on the Federal Reserve to consider a more accommodative policy stance.

Gold faces a crucial test after its breakout

Key resistance now comes in around $4,365 to around $4,425 area. This area was tested on Friday and remains intact for now. Here, a prior swing low from February meets a support-turned-resistance area.

Short-term support now comes in around $4300/5 area, followed by $4,200 and then the base of the breakout around the $4,100 to $4,120 area.

In theory, gold remains one of the clearest beneficiaries of a dovish shift in US monetary policy. Last week’s rally has already demonstrated how quickly the metal can respond when the dollar and rate expectations move in its favour.

The challenge now is whether buyers can build on that momentum. After such a strong weekly advance, some consolidation would hardly be surprising. More importantly, however, the market needs to see continued support from softer US data if gold is to turn the latest rebound into a more durable bullish trend.

For now, the fundamental backdrop has improved for gold, but Wednesday’s CPI report could determine whether last week’s surge was the beginning of the next leg higher — or simply a temporary reprieve for the bulls.