Although gold opened virtually flat this morning, just 0.10% above unchanged, the rest of the precious metals tumbled into the red as markets price in the rising odds of a December rate hike from the Federal Reserve. Today's action in trading will largely be bargain-hunting as both gold and silver are not far off from their lowest levels of 2015.
This does mean, however, that a bounce-back is likely in store.
Rate Hike Reversal
Where just a few weeks ago it seemed the Federal Reserve had lost all credibility in its year-long quest to raise interest rates, the markets have now swung to believing that an interest rate increase at the Fed's next meeting in December is all but a certainty. The chart below demonstrates the swift change in outlook (as well as how long this "Will They Or Won't They?" has been going on).
This development has helped boost the dollar, as the currency almost invariably strengthens whenever monetary policty tightens. In other words, higher rates generally spell a rally for the dollar. The USD has surged some 5.5% against its peers since mi-October to 99.1 on the DXY index, its best since April—a 7-month high.
By and large, what's supportive of the dollar is bearish for gold and the precious metals. This relationship has held to form, as spot gold ($1,090/oz on Monday morning) is not far off from its yearly low of $1,071.28 per ounce. Meantime, silver ($14.70/oz) is only a few moves lower shy of its bottom for 2015 around $14.40/oz.
Platinum and palladium both also fell on Monday, losing 2.8% (-$26/oz) and 3.7% (-$23/oz), respectively.
Potential for Gold and Silver Rebound
The rate hike reversal seems on its face seems to indicate rough times for commodities in general. Since the Fed put a December rate hike in its crosshairs, ETFs tied to gold and silver or the Platinum Group Metals (PGMs) have seen fresh outflows: 27 tonnes left gold ETFs last week, while PGM ETFs lost 9% of their total investment.
Yet, there may be a convincing case for the metals responding differently once such a rate increase comes.
One fact is that even as the markets largely price-in the chance of interest rates going up, they haven't quite taken into account that the size (and probably the subsequent pace) of rate increases is going to be very shallow. By their own estimations, analysts don't expect the federal funds rate to go up by more than 12.5 basis points—merely 1/8th of a percentage point. A full quarter-point (25 bp) rate hike would be more dramatic, but is less likely, anyway. So, if it turns out that the impact of rate increases is more gradual and subdued than traders' initial reaction to the news would indicate, this could send the precious metals higher.
This point could also reveal that the precious metals are oversold at the moment. In general, strong economic reports in the U.S. tend to cause traders to "overshoot" on the metals, and this tendency is subsequently corrected for. This could prove especially true if the Fed raises rates very slowly or if the markets become jittery about the ongoing uncertainty in emerging markets.
On the demand front, there are also signs that industrial usage of silver could be back on the rise. USGS reported that U.S. silver imports rose 15% from July to August, a solid 18% increase year-on-year. This could combine with strong retail demand (American Silver Eagle sales were up 4% year-on-year through the first 3 quarters) to lift silver prices. Industrial uses account for more than half of silver demand annually, so any uptick in this sector could fuel a recovery in prices.
The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.