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  • Rising inflation expectations gave XAU/USD a boost on Monday.
  • The precious metal rallied to highs around $1840 from earlier lows under $1810.

Spot gold prices (XAU/USD) rallied on the first trading day of the second trading week of the month; having hit lows just to the south of the $1810 mark during the Asia Pacific session, gold prices saw a substantial pickup during the European session and into US hours, rallying to highs of just to the South of the $1840 mark. In recent trade, the precious metal has slipped back towards $1830, up just under 1.0% or around $17 on the day.

Should the bulls regain control as the Asia Pacific session gets into full flow, the next area to watch will be a test of the 21-day moving average at $1844. Above that, the 50 and 200-day moving averages reside fairly close to each other in the mid-$1850s.

Rising inflation expectations boost precious metal markets

The reflation trade was alive and well on Monday; commodities were boosted across the board and stocks were up. Bets on higher inflation ahead were evident in the US bond market; nominal US bond yields rallied above some key psychological levels, with the US 10-year rallying briefly above 1.20% and the US 30-year rallying briefly above 2.0%. Moves higher in nominal yields were not coupled with moves higher in real yields of the same magnitude, thus break-evens moved higher; 10-year break-even inflation expectations (the difference between the nominal and real yields on US 10-year bonds, which is the market’s implied average expectation for Consumer Price Inflation over the next 10 years) rose to its highest levels since 2014 of above 2.20%.

In terms of why inflation expectations have been moving higher, it is a combination of factors;

1) Congress is soon expected to pass another substantial (debt-financed) fiscal stimulus package which will increase present-day demand in the US (at the expense of future demand, which will be hurt when Americans have to pay higher taxes to pay back the debt), pushing up prices.

2) The Fed continues to signal that it ensure monetary conditions remain highly accommodative for the foreseeable future and that it is happy to see inflation overshoot its 2% target modestly for a time. In other words, the Fed is intent on continuing to pursue it inflation inducing policies (low rates encourage lending, which increases money supply and prices, while QE represents the literal prints of money and a direct expansion of the money supply).

3) Vaccine rollouts continue at a pace in most major developed economies and virus infection rates are dropping, pumping hopes for an aggressive rebound in economic activity over the Summer and into 2022 – sectors such as hospitality and leisure (which have been forced shut by lockdowns and are expected to see huge demand as consumers “make up for lost good times”) are unlikely to be able to cope with this demand without pushing up prices.

Given the upwards pressure that all of the above place on inflation, any asset that is seen as a hedge against inflation is set up to do well. Precious metals are seen as the “ultimate” inflation hedge/store of value, hence why Gold has a positive correlation to rising inflation expectations. Thus, one threat to gold going forward might be if inflation underwhelms for a prolonged period of time, though in this case, central banks would likely maintain highly accommodative monetary policy, which would likely be a precious metal positive.

Perhaps then the big threat would be if inflation surprised to the upside, given that the risk would be that central banks would have to rapidly wind in stimulus measures and perhaps even start tightening again.