Gold sees a breathtaking rally as Middle East conflict intensifies

Gold staged a stunning rally on Friday on escalation of the Mideast conflict. The situation took a grave turn after Israel gave Gaza Palestinians twenty-four hours to evacuate the Gaza Strip as the Israeli army prepared for a massive assault in Gaza. The ultimatum sent huge ripples of heightened geopolitical tensions that put a solid bid under gold prices, taking the metal to its best single-day rally in almost seven months. Once the metal cleared the key resistance at $1900, it culminated into a massive short squeeze as quite a few short positions have been built up over the last few days when the metal yielded the $1900 level to the bears.

Gold’s rally was unfazed by rallying US Dollar, which despite a pullback in the US yields, extended its Thursday’s advance. The metal closed with a huge gain of 3.32% at $1932 Friday. The yellow metal recorded a gain of $100 on the week as the ten-year US yields were down nearly 4% to 4.61%. The US Dollar Index closed with a gain of 0.60% at 106.67 on a weekly closing basis.

The United Nations said that it would be impossible for millions or so inhabitants of North Gaza to move over to the South at such short notice. It may lead to a humanitarian disaster. In the meantime, thousands of people across the Middle East rose in protests against Israel’s planned assault on Gaza.

In a major blow to US President Biden’s vision and strategy for the Middle East, Saudi Arabia has decided to pause its diplomatic efforts to normalise ties with Israel, which means that oil prices are likely to march higher.

European Central Bank’s President Christine Lagarde said that they will hike interest rates further if there is a need to; however, market participants think that in all probability, the ECB is now done with hiking rates.

The notion that tighter credit conditions don’t warrant further hikes is gaining currency as the officials of both the Federal Reserve and the ECB are pushing this narrative. In their recent speeches, all the Federal Reserve officials except Governor Michelle Bowman have cited high yields as a good reason to keep the interest rates unchanged in the near future.
Elsewhere, China is looking to increase the amount local governments can borrow, state media reported. It is to be noted that the Chinese economy seems to be losing momentum yet again as reflected in the September CPI inflation data, which came short of expectations. Chinese Banks’ loan growth in September fell YoY, too.The US inflation data was released last week. The headline CPI increased 0.4% (Vs 0.6% in August and expectation of 0.30%) as the YoY change was noted at 3.7%; however, the reading was higher than the forecast of 3.60%. Core inflation remained at 0.3% MoM, which matched the consensus expectation— with the YoY reading edging down to 4.1% as expected (Vs 4.3% prior). Thus, the annualized core CPI is running at 3.9%, which is substantially higher than the Fed’s 2% target. Energy prices contributed about 11 basis points to the headline.

While Core goods prices declined 0.4% (vs. -0.1% prior), the fourth consecutive month of decline, driven by a surprising 2.5% drop in used-car prices, core services accelerated to a robust 0.6% (vs. 0.4% prior), driven primarily by rents. Owners’ equivalent rent rose to 0.6% (vs. 0.4% prior). The University of Michigan Consumer Sentiment fell to 63 in October from last month’s 67.80, whereas Inflation expectations for one year rose from 3.2% to 3.8%, while for five years jumped to 3% from 2.8%.

Next week, investors will focus on China’s GDP (3Q), retail sales (September), industrial production (September), and PBoC’s interest rates decision on 5-year LPR and 1-year LPR; the US retail sales (September), industrial production (September), housing starts (September), Philadelphia Fed business outlook (October) and existing home sales ( September); UK’s monthly job report (September), CPI (September), retail sales; the Euro-zone’s CPI inflation data, ZEW Survey expectations; and Germany’s ZEW Survey expectations.

A sharp turnaround in gold’s fortunes has come unexpectedly due to the geopolitical factors rooted in the Mideast this time. The metal is up more than 6% from its cycle low of $1810 seen just a few days ago. Going forward, the yellow metal can be extremely volatile as traditional factors like the Dollar and yields don’t warrant such high prices. Still, gold, in the very short term, will depend primarily on the situation in the Mideast. The yellow metal may trade between $1885 and $1975. The interim support and resistance levels are $1900 and $1950 respectively.

The metal is expected to find good support in the dips as geopolitical risk premium rises. If the situation continues to simmer, buying the dips with a strict stop loss will be a preferred strategy.

(The Author is Associate Vice President, Fundamental Currencies and Commodities, Sharekhan by BNP Paribas)

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