Gold Market Commentary: Hiking up a volcano

Nothing to see here

Gold fell 1% in May, finishing the month at US$4,546/oz, and marginally lower in most major currencies. India and Turkey saw monthly gains (Table 1).

According to our Gold Return Attribution Model (GRAM), there were no stand out drivers for gold’s performance in May from the explicit variables in the model (Chart 1). Positive risk sentiment via equity inflows less bond inflows and a fall in implied volatility proved a minor drag, alongside gold ETF outflows from Asia and the US (US$2.3bn, 17.3t). US dollar weakness helped gold at the margin as did momentum factors including European gold ETF inflows (US$0.3bn, 1.2t). Other opaque flows – possibly in the over-the-counter (OTC) market not captured explicitly in our model - may have been a contributor to the negative residual.

COMEX managed money futures positioning continued to linger in neutral territory with a very modest gain of US$1.4bn (8t) in May.

Hiking up a volcano

• The Fed may have to hike later this year and that could spell trouble for risk assets and the economy. History is mixed when it comes to hikes and gold’s response
• Notable precedents show similarities to today and on those occasions gold responded positively to a hike
• But gold is also facing near-term headwinds and significant oil shock could prolong the malaise.

Following a somewhat contentious US rate-cutting cycle that began in 2024, the market has pivoted to the strong possibility of rate hikes into year-end and beyond, with a firm economy facing pass-through inflation pressures. This could weigh on risk assets through discount rates, as well as increase borrowing costs for households and businesses.

Convention has it that higher policy rates pressure gold through higher real yields and a stronger US dollar. The evidence is mixed. Historically, rate hikes have not seen a uniform response from yields, the dollar or gold.

It is our view that a hike may counter intuitively benefit gold when it happens. Here is our case:

• The data: Gold has positively surprised on hikes more than 50% of the time. It’s median one-month (21-day) return following hikes – adjusted for the long-run average 21-day return of 0.84% – has been positive.¹
• Context: What matters more than the policy rate itself is how markets interpret the implications of tightening for growth, inflation credibility, financial stability and the US dollar
• This time may be different: In prior cycles, hikes often signalled policy credibility and economic normalisation. Today, however, hikes may increasingly signal:
  • Persistent inflation pressure as resource nationalism ramps up
  • Fiscal stress both in the US and abroad
  • Policy error risk on more divergent FOMC views, political pressure and the fear of getting it wrong (again).
• Cue the US dollar: Historically the US dollar appeared more important to gold’s fortunes than to rates. Medium term growth and yield convergence, and a diversification push away from US assets, has set quite a clear path for a weaker dollar ahead, upon which consensus is agreed.
• Other things matter: Demand from China, India and central banks is structurally less sensitive to US rates and could provide support beyond the current lull
• Risk asset fragility: Higher rates may prove to be the last straw for equity markets. Aside from the mechanical repricing of discount rates, Vanda Research notes that even relatively modest rises in long-end Treasury yields have repeatedly destabilised short-term equity rallies over the past couple of years.²

When and why hikes benefited gold
There are notable historical precedents during which gold bucked expectations with a positive hike (Chart 3):

To boot, several near-term headwinds remain in place.

Some physical markets appear to have softened, with discounts in India, South Korea and anecdotal evidence of some selling in Japan. Global gold ETF flows have been lacklustre in May. The possibility of sporadic official-sector swaps or sales remains as the Hormuz Strait standoff continues. Technically, gold remains vulnerable – perched on its 200-day moving average, in what looks like a declining channel.

The largest near-term risk may come from energy markets. Oil is dominating headlines and inflation expectations, as well as driving bond yields (Chart 5). A sharp rise in energy prices driven by inventory depletion could initially push yields higher, strengthen the dollar and extend gold's current malaise before the longer-term implications become apparent.⁷

Our main models generally associate rate rises with gold price falls, with price rises the exception rather than the rule. The argument here is simply that if hikes ultimately arrive, there is a reasonable case for the exception to occur. Rather than reinforcing confidence, markets may interpret them as evidence of underlying fragility.