The price of gold suffered a sharp decline at the end of September, taking it to its lowest level since February of this year. In the short term, what central banks decide is now very important for gold.
The price of gold fell 4.7 percent in September and ended the month at $1,848.1. At the beginning of October, the price decline has continued, with the price of an ounce at $1,822 by October 5.
The price of silver fell by a total of 9.2 percent and ended September at $22.2 per ounce. Silver has also continued its rapid depreciation at the beginning of October and is currently trading at $21.1.
Mainly, the tougher tone of central banks regarding interest rates, the rapid growth of bond yields and the strengthening of the dollar have exerted pressure on gold.
Gold broke through important support levels
After several months of high levels, gold broke through key support levels in September. Gold overpassed the $1890-1900 level as well as the $1850 level. The next important support level is at $1,800. Looking at the technical picture, gold is clearly showing weakness.
During the rapid fall that began at the end of September, gold fell by nearly $100 in just six trading days. Some stabilisation is expected in the first half of October, if the $1,800 level holds. This is also the level where gold found support after the decline in February this year.
The next strong support level is for gold at $1,680 and then at $1,615, where gold formed a triple bottom last fall (falling to the same level three times in a row). As a long-term investor, I see both the $1,800, $1,680, and $1,615 levels as very attractive buying positions.
The trajectory of interest rates has exerted pressure on gold prices
The rapid depreciation of the bond market and expectations regarding interest rates are highly affecting the price of gold. In the US, the Federal Reserve signaled that interest rates may remain higher for longer than expected.
In addition, the central banks of England, Switzerland and Japan have also taken a surprisingly tough tone. The European Central Bank has also expressed that they would rather keep interest rates at a high level. As there is currently a lot of uncertainty for investors regarding the direction of interest rates a few years out, with statements from central banks being watched very closely. This is also the reason why even small changes in rhetoric have affected the price of gold so much.
Changes in the rhetoric of central banks have also been accompanied by a rapid drop in bond prices. For example, the yield on 10-year bonds in the USA has already risen to 4.7 percent, surpassing the peaks reached in October last year. At the same time, the yield on the bonds in question rose to the highest level since 2007.
If the price of bonds falls, their yield rises. At the same time, the bond market also affects gold in many ways, because the rise in interest rates increases the opportunity cost of gold (loss of income if one investment is chosen instead of another).
Real interest rates also have a great influence on gold (inflation is deducted from the interest rate). As the inflation level is coming down, but bond yields are rising, real interest rates are also rising rapidly.
The dollar is strengthening again
The rapid strengthening of the dollar in recent months and the depreciation of other currencies are also significant. Both the euro and the British pound have been hit hard. The euro fell at the fastest pace since May this year in September, the last time the pound did this badly was a year ago.
The dollar index has risen by nearly 7 percent from the lows reached in July this year. Before that, the dollar had been in a downward trend for 10 months. Last October, the dollar rose to its highest level since 2002. The last price bases for gold mentioned earlier (ca. $1,615 level) date from that time.
A stronger dollar makes gold more expensive for users of other currencies. This means that a stronger dollar will negatively affect the price of gold.
What happens next?
All the factors mentioned above are the main reason why gold has become so sharply cheaper in the short term. Over the coming months, the rate of inflation and the rhetoric of central banks regarding interest rates will be key for the price of gold.
If the US decides to raise interest rates one more time in November, it would have a negative effect on gold in the short term. If you look at the technical picture, gold is currently rather weak, at least in the perspective of a few months.
According to CME FedWatch data, markets see a 25 percent chance of a 0.25 percentage point rate in November. In the short term, what matters for gold is what decisions the central banks take at the end of the year.
It is worth following the interest rate curve
However, if you look at the broader picture, I think it is important to observe the inversion of the interest curve, which indicates the coming of an economic recession. Although there are other indicators, I will focus here on analysing the yield curve.
In short, an interest rate curve shows how big the interest rate difference is between long-term and short-term borrowing.
The interest rate curve inverted (the interest rate on short-term loans rose higher than long-term loans) last year, when the yield on US 2-year bonds rose higher than that of 10-year bonds. Meanwhile, short-term bond yields were 1.1 percent higher than long-term bonds, and now their gap has started to narrow again.
As a rule, recessions have come after the yield curve has inverted again (long-term interest rates rise above short-term rates again after the yield curve inverts). This logic applied to the tech bubble of the early 2000s, the financial crisis of 2008, and the corona crisis of 2020.
Currently, we see how the interest rate spread is strongly approaching 0 percent, based on which one could assume that the recession may not be far away. Of course, there is nothing certain about it, but the yield curve has historically been very good at predicting economic downturns and crises. They have not typically been positive for equity markets.
Expect lower interest rates and money printing
If the situation in the economy worsens, central banks will probably respond by lowering interest rates and printing money. This is also the reason why I believe that the cycle of rising interest rates is over (or about to be over) and that monetary policy will be eased quite aggressively next.
Although in the short term economic recession can have a bad effect on gold, the longer-term policy of central banks (2-5 years) will be very supportive for gold.
If you look at the fundamental picture, gold purchases by central banks have receded from record levels, but remain high.