Risk of significant reversal in gold price rally as inflation report looms, says TD Securities

(Kitco News) The strong employment report proved that the U.S. economy is still expanding despite two consecutive negative quarterly GDP releases. And for gold, this means that the price rally could be at risk, according to TD Securities.

In reaction to the U.S. economy adding 528,000 jobs in July, gold lost 1% on Friday. The July report more than doubled economist expectations of additional 250,000 jobs. On Monday, gold staged a recovery, with December Comex gold futures rising back to $1,793.00, up 0.70% on the day.

Friday’s selloff was led by a shift in sentiment that markets were premature to price in a Federal Reserve pivot from the aggressive tightening cycle, said TD Securities head of commodity strategy Bart Melek.

“The 528k increase in payrolls, unemployment drop to just 3.5% and the outsized 5.2% y/y jump in earnings growth all suggest the U.S. economy is expanding, despite the two consecutive negative quarterly GDP prints,” Melek said Friday. “This, along with service sector robustness and given the U.S. consumer has larger-than-normal holdings of cash in checking accounts and money market funds, which sit at around three trillion dollars, all suggest that there are plenty of inflationary pressures in the system.”

This week, the attention will be on the July inflation report out of the U.S., with economists projecting the annual inflation pace to come in at 8.7% after rising to 9.1% in June.

According to Melek, inflation will continue to be stubbornly high, and the metric to watch would be the core inflation number, which excludes the food and energy sectors. “Core CPI may continue to increase, even as lower energy prices drive down the headline level,” he said. “The U.S. July CPI data next week, particularly the core, will be the one to watch as any hint of stubborn inflation pressures in the system should help to debunk the early pivot argument.”

Economists’ consensus calls expect the annual core inflation number to accelerate to 6.1% after coming in at 5.9% in June.

For gold, this could mean a significant reversal of the move that took prices from below $1,700 to nearly $1,800, Melek pointed out, citing reduced exposure to the precious metal.

“There is a high probability that the recent rally, which took prices from a July low of $1,681/oz to a high near $1795/oz, will be largely reversed as money managers reduce recently acquired long exposure,” he said. “The combination of hawkish statements from Fed officials and stronger-than-expected data are the likely catalysts which can trigger additional selling in the days and weeks ahead.”

Last week’s hawkish Fed speakers pushed back against the idea of the U.S. central bank pivoting from rate hikes.

Chicago Fed President Charles Evans said the U.S. central bank would likely keep using oversized rate hikes until it sees inflation coming down. “If you really thought things weren’t improving…50 (basis points) is a reasonable assessment, but 75 could also be okay. I doubt that more would be called for,” he told reporters Tuesday.

San Francisco Fed President Mary Daly stated that inflation is still a problem. The Fed has “a long way to go” before it reaches its price stability goals, Daily said during an interview on LinkedIn. “We are still resolute and completely united,” she said.

St. Louis Federal Reserve President James Bullard also noted, “we still have some ways to go here to get to restrictive monetary policy.”

On top of that, Richmond Federal Reserve president Thomas Barkin admitted that the Fed is willing to pay the price for getting inflation under control. “There is a path to getting inflation under control. But a recession could happen in the process. If one does, we need to keep it in perspective: no one canceled the business cycle,” he said.