Fears of financial contagion could keep gold near record highs

COMEX gold prices are trading near a one-year high of $2014.9 per troy ounce notched in the previous week.

The yellow metal started the week on a negative note, as the SNB brokered UBS buyout of Credit Suisse calmed markets and improved the risk sentiments.

There were also reports that the US officials were studying ways to temporarily expand Federal Deposit Insurance Corp. The share price of US regional banks recovered, while safe-haven assets took a hit.

However, things changed post the FOMC meeting. During the March FOMC meeting, Fed raised the fed funds rate by 25 bps to 4.75%-5%, pushing borrowing costs to the highest since 2007.

The FOMC dot plot chart showed that the end-2023 fed funds median forecast is at 5.1%, which is the same as the December projection, suggesting that Fed may hike by another 25 bps in the May meeting and then go for a pause.

Fed chair has acknowledged that we are nearing an end to the rate hikes in this cycle, prompting a decline in US treasury yields and the dollar index, aiding bullion.

Despite Powell reiterating for holding rates throughout the year, markets are expecting a cut of more than 90 bps in 2023, taking into account the lags in monetary policy and the fact that Fed will have no choice but to cut rates, with a recession knocking at the door.Investors were also baffled by Powell-Yellen’s contradictory statements. During the post-FOMC presser, Fed chair Jerome Powell said that all depositors’ savings are safe.

However, at the same time, US Treasury Secretary during a hearing before a Senate sub-committee said that regulators aren’t looking to provide “blanket” deposit insurance to stabilize the US banking system without working with lawmakers, and that the heads of recently-failed American lenders should be held accountable, putting the focus back on the weak regional banks.

Going forward, we expect record-high prices to have an impact on domestic retail demand. However, central bank buying coupled with ETF inflows might more than offset it.

Amid elevated inflation, rising risks to the financial system, and geo-political uncertainty, central banks might remain positive and continue to be net purchasers in 2023.

SPDR Gold ETFs have witnessed a good amount of inflows during the past week and are hovering at a 6-month high of 925.42 tonnes as of 23rd March 2023.

Meanwhile, money managers’ net speculative positions have risen to a seven-week high of 85,362 lots, up 61,256 lots for the week ended 14th March 2023.

Banking sector fears continue to haunt risky assets. In the latest moves, Deutsche Bank AG shares slumped on Friday and the German lender’s credit-default swaps surged amid wider concerns about the stability of the banking sector.

Meanwhile, UBS Shares fell after Bloomberg reported the bank is under scrutiny in a US Justice Department probe. We have seen the most aggressive policy tightening cycle in 40 years and this heightens the chances of economic and financial stress.

Money markets are now pricing in March rate hikes as peak rates and expect a 100 bps of rate cuts by year-end. Gold prices have always fared well, with Fed cutting down the rates.

No major events are scheduled for the coming week and thus the health of the banking sector will be in focus.

We might see gold prices trading with an upside momentum as new events unfold each day and amid rising odds of a financial contagion into the broader economy.

(The author is CMT EPATian, VP-Head Commodity Research, Kotak Securities Ltd)