Why there may be more upside for gold

Gold has been on a record-breaking run as the markets consider what's next for the Federal Reserve and the potential for rate cuts. But does this rally in the precious metals still have some momentum behind it? Joining us now to discuss Bart Melek, global head of Commodity Strategy with TD Securities. Bart, great to have you back on the program. It's wonderful to be back. All right. So these are interesting times when I was seeing gold hitting fresh highs in recent days. I said, good thing we got Bart coming up. What's been behind this rally? What did we see? Why did we see the move? Well, I think it started to-- you know, after some bad data over a week ago that came in and basically the market concluded that, with weakening economic numbers, the Federal Reserve is more likely than not to cut rates this year. We're still not sure if it's May, June, or later, and how many cuts that will be, but I think the market is basically pricing in cuts. And with that, we've had a market that was under-positioned in gold. So we've seen, from our perspective, significant amount of short covering. And we've also seen funds take on new long positions. And that hit some technical triggers, ctas. The systematic funds got in on into the action and prices moved into new highs over just around above 2200. And we were there for a while. And of course, we've had another set of data this morning that reversed some of that momentum. Let's talk about that data, of course, because obviously, the equity market seems to be brushing it aside, but you still have inflation south of the border, stuck above 3%, hotter than expected, but there seems to be this optimism from the equity side. That don't worry, it'll all work out in the end. I mean, what is the dynamic here? And it seems to have more of an effect on gold than anything else today. Well, sure. You know, gold-- we have to say that gold very much trades like a 0 coupon 30 year bond with more convexity. So it's very sensitive to rates, particularly real rates. And when the forward curve in the Fed funds sells off a little bit, then carry gets impacted. And I think we've seen some profit taking today. And we might have seen less appetite for taking on long positions. I mean, what happened? Well, we had the core number come in higher than expected. And I think the core is the important one here is the less volatile part of the inflation index. The headline came in a little higher, as well. The core was at 3.8. Well, that's certainly a lot higher than the two target. And the core-- In fact, the core PCE is what the Fed looks like. CPI is a proximity to that, a good proxy. So what does it tell us? Well, it may be that the US Central Bank may not be quite ready to cut rates just yet. They've made it quite apparent that they expect rates to come off this year, but I think we're just quibbling about when exactly that will be and how much. So for now, I think there's less buying momentum because of that number. We see prices moderate a bit. In fact, I put out a note to that effect on our real time analytics on our portal, where I'm saying that there is strong support about 20, 25, 27.5, somewhere around there. I wouldn't at all be surprised if we gravitate to that level just because of that uncertainty of when the Fed goes following these numbers. Now, what do we think longer term? I like gold. In fact, I changed the forecast to 20 to 50 for the next quarter. Where we do think that, ultimately, we're going to get lower rates. Real rates will come down. And we're still seeing fairly robust activity on the physical side. In fact, it was the physical side of that supply demand equation in gold that has kept gold around 2000 at a time, where the Federal Reserve was really tightening up severely over last year or conditions-- the momentum of tightening from the Fed slowed. But as inflation fell off, those real rates became quite restrictive here. And gold did very well, which is usually not the case. It was Central Bank buying, right? You would sort of highlight that every time you'd come on last year. The central banks were buying gold. The central banks bought a record amount of gold in 2022. And 2023 was not far behind. And there is every indication that central banks will continue to be very robust buyers of gold this year as well. There are many, many reasons for that, one among them is that, ultimately, they're quite worried that, in fact, no matter who the future president of the United States will be, that will continue to be sky high. We've seen attempts by the current president try to address some of that. But in the end, there are a lot of unfunded liabilities that the US is facing, which may very well mean that deficits continue to be quite a lot. And there isn't a lot of appetite, as far as I'm concerned, in the United States to pay the taxes that are required to balance all these budgets. On the other hand, we're seeing continuing geopolitical risk. I wanted to ask you about that, right? Because if you're worried about the politics in Washington and the debt level, but there's no shortage around the planet of things to be worried on the geopolitical side. Well, you know, we've got the Middle East. We've got, specifically, problems in the Red Sea. But when it pertains to gold specifically and central bank buying, the People's Bank of China continues to be quite active. One of the reasons we think may very well be is they're trying to diversify away from fiat currencies that can be sanctioned. We're in no way projecting anything, you know, violent in terms of Taiwan. But I think the tensions are there and the risks are there. You don't actually have to believe something is going to happen, but if the probabilities start increasing, then it may be wise for a country like China, which has some $3.2 trillion worth of FX reserves, and, you know, 3.4, I think, at this point percent is represented by gold, versus 60 plus around 70 in the US. And its other geopolitical partners have-- competitors, I would rather say-- have a lot more. It may make sense for them to diversify away from the dollar and other currencies. One, there's too much concentration, if you're worried about the long term viability of the US dollar. We're not saying it's going to collapse or anything, but there is a risk out there that, over time, if you have these deficits, you might have to start monetizing in some way as the population ages. These expenses relative to tax revenue will continue to increase. And there are other realities that trade has shifted away from Western-centric flows to more global. So it makes sense for them, for all these reasons, to diversify their foreign exchange holdings. And that could mean an awful lot of gold. I think I estimated 2,800 tons if China increases its current holdings to 10% of its reserve. So those two components. If we see physical strong jewelry in China, central banks, and we're going to start seeing more discretionary traders getting into gold, as rates drop off, and the concern of course, is that the Federal Reserve will start cutting rates before those measures are at 2%, that's what it looks like. The market may worry about credibility. Is 2% a real target or is this just something the Fed says? If you start cutting aggressively when inflation is still in the mid threes, for example, then you might want to hold gold as a hedge.

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