Gold poised to jump as Fed likely to hit pause button on rate hikes in 2019

Gold may be poised to rally as speculation mounts that the Federal Reserve will hit the pause button on interest rate hikes in 2019.

After lift-off in late 2015 followed by a rise a year later, the central bank has since steadily raised benchmark rates and is widely expected to do so again this month. But the path after that is clouded after Chairman Jerome Powell said Wednesday rates are “just below” estimates of the so-called neutral level, which markets took to mean a softer stance than previous comments.

It was “getting pretty obvious that at some point Powell would have to flinch,” said Trey Reik, senior money manager at the U.S. unit of Sprott Inc., which oversees $7.6 billion. “Once you get to the consensus view that the Fed may be done, the dollar may come under severe pressure. Gold will erupt.”

While bullion was weighed down in the second and third quarters by a stronger dollar and rising borrowing costs, the dynamic may now be shifting as doubts build over the Fed’s tightening path in 2019. Drivers that favor further gains in bullion include a steady build-up in exchange-traded fund holdings as well as votes of confidence from top banks.

Goldman’s View

Goldman Sachs Group Inc. recommends an outright long gold position into next year. “If U.S. growth slows down next year, as expected, gold would benefit from higher demand,” analysts including Jeffrey Currie said in a Nov. 26 note that endorsed bullion as one of its top-10 trade ideas for commodities. “The market has already priced in 10 out of the 12 rate hikes that we expect.”

Last week, futures capped the first back-to-back monthly gain since January, and on Monday they traded at $1,228 an ounce. That uptick followed two quarters of declines through to September, with prices hitting a 19-month low in August. So far this year, bullion’s still down more than 6 per cent.

On Wednesday, Powell offered few explicit clues on how many hikes will be necessary in 2019, but repeated his view that the Fed will have to be especially responsive to the data. Minutes the next day, which covered the Fed’s last meeting, signaled policy makers will adopt a more flexible approach in 2019.

Powell had earlier stirred a debate over tightening when he flagged potential headwinds to the economy amid a sell-off in equities and concerns over slowing global growth. On Wednesday, he remained upbeat, forecasting continued solid growth, inflation near the 2 per cent target and low unemployment.

‘Cue to Buy’

Joblessness stood at 3.7 per cent in October, well below the rate the Fed sees as sustainable in the longer run. Any tick up in unemployment next year could see a pricing out of hike expectations, according to Chris Weston, head of research at Pepperstone Group Ltd. in Melbourne.

“If people get a sense that unemployment’s going up, heaven forbid, we’re going to see great volatility in 2019,” Weston said by phone on Nov. 29. “That’s going to be a cue to sell the dollar, and that’s going to be a cue to buy gold in much bigger size.”

Higher rates are seen to weigh on bullion, which doesn’t bear interest. Yet in the two most recent U.S. hiking cycles, gold has risen even as equities climbed because the Fed lagged inflation, which meant that cash in the bank lost purchasing power, making gold a more appealing store of value, said Adrian Ash, research director at London-based BullionVault Ltd.

“By themselves, Fed rate hikes aren’t always bad for gold and cuts aren’t always good,” said Ash. “Across longer periods, what the Fed does matters less to gold than why it changes policy and how the stock market reacts.”

During the previous tightening cycle from mid-2004 to 2006, when borrowing costs rose to 5.25 per cent, gold surged more than 50 per cent. Since December 2015, bullion’s up about 15 per cent, although it’s lost ground this year.

Still, some say the Fed will continue hiking. Powell’s speech essentially said the economy is doing well, and asset prices are not in a bubble, but that rates are close to ‘neutral’ although people dispute what that is, according to Nicholas Frappell, global general manager at Sydney-based ABC Bullion.

“Gold may struggle to rally,” Frappell said. “Gold will face a longer period of Fed tightening before the interest-rate cycle turns in 2019.” U.S.-China trade issues could also dominate the Fed’s narrative, he added.

All eyes will now be on the Federal Open Market Committee’s final gathering of this year on Dec. 18-19 to glean further clues on what may happen. In language following that policy meeting, officials may convey “sufficient softening of future expectations,” said Sprott’s Reik, who’s expecting the central bank to halt rate hikes next year. He sees gold prices climbing to $1,360 in the first half and potentially hitting $1,525 in 2019, a level last seen in 2013.