Gold slumps to 6-month low even as inflation fears rise. Here’s why bullion is out of favor

Gold fell to a fresh six-month low on Thursday as investors dump the once-hot trade on growing concern that higher inflation will force the Federal Reserve into possibly raising rates later this year, or at least keep them steady.

But there are also other factors at play.

August gold futures touched $4,046.20 an ounce on Thursday, their lowest level since November. Gold is down 6.3% this week alone, putting it on pace for a second straight weekly loss and its worst week since mid-March, when gold fell 9.62%.

It was last down 0.5% to $4,111.10 an ounce.

Fed reversal

As a safe-haven asset, investors gravitate toward the yellow metal during times of market uncertainty and in hopes that it will act as a hedge against inflation. But because gold doesn’t yield anything, the metal is also especially sensitive to expectations for long-term, real interest rates.

The Iran war, now in its fourth month, has fueled inflation by pushing energy and other prices higher.

U.S. consumer inflation in May increased at its fastest pace in three years, mainly from the surging prices of energy-related products. Together with a stronger-than-expected May jobs reports, expectations have grown that the Fed may need to raise interest rates by the end of the year to slow down price increases. 

Next week, the Federal Reserve is expected to hold its benchmark lending rate steady at 3.50% to 3.75% during Kevin Warsh’s first meeting as Fed chair. A majority of ⁠economists in a Reuters poll expect interest rates to remain unchanged ⁠this year after many were penciling in multiple rate cuts to start the year.

Traders are less sanguine, and are currently pricing in a 67% chance of a Fed rate hike by December, according to the CME Group’s FedWatch tool.

Higher rates, if they help stamp out inflation, can make dollar-denominated assets such as Treasury securities more attractive. 

The technical breakdown

Based on price chart analysis, the overall technical picture for gold remains weak.

Gold recently broke below its 200-day moving average for the first time since September 2023, which Citigroup flagged as a major negative signal. The bank has been cautious near term on gold ever since the war escalated in March, partly due to higher energy costs springing from the closure of the Strait of Hormuz.

In the long term, Citi remains bullish.

“While market participants struggle with the short-term outlook, which relies heavily on the Strait of Hormuz outcome, the consensus view remains constructive over the medium to long term on robust non-cyclical demand from increasing global geopolitical fragmentation, lingering sovereign debt and debasement concerns and sustaining central bank reserve diversification trend,” Citi analysts said.

Retreat from the ‘debasement trade’

JPMorgan sees a broad-based retreat of the “debasement trade” by retail and institutional investors.

The withdrawal from that trade that started to emerge a couple of weeks ago has continued in recent weeks.

The bank cited outflows from gold exchange-traded funds and weaker futures positioning due to growing concerns around the size of the government deficit, longer-term inflation backdrop, higher geopolitical uncertainty since 2022.

“Our momentum signal framework also points to a continued retreat from the debasement trade. The pattern since the start of the Iran conflict has been similar to ETF flows and the futures positioning proxy,” the bank noted.

JPMorgan’s analysis shows gold ETF outflows of around $20 billion in the week to June 5 after modest inflows in the prior week while bitcoin ETFs recorded gradual increasing outflows over the previous four weeks.

In the futures space, investors continued to unwind exposures to the debasement trade. The bank noted that reduction to gold had started from end-February and has remained steady since mid-April