Can gold stop the slide?

Last week we wrote about how despite the significant headwinds faced by gold, it seemed to be standing up to them. The conclusion being that if gold was behaving this way in the face of significant pressure, then what would it do when that pressure started to ease. Well, unfortunately that pressure finally came to light and gold gave way on Monday with a pullback of 4% at one point.

After weeks of standing firm against rising interest rates, a stronger dollar and climbing bond yields, the pressure became too much with Mondays trigger coming from the familiar source of the conflict in the Middle East. President Trump rejected Iran's latest proposal to reopen the Strait of Hormuz, sending oil sharply higher and reviving concerns that the conflict could keep inflation elevated for longer. Brent crude climbed above $108 a barrel at one point on Monday before easing later in the session.

As we've covered before, the conflict in Iran and its impact on oil leads into US (and global) interest rates and monetary policy that also impacts gold. If oil remains expensive, businesses and consumers pay more for energy and transport, which keeps inflation higher. If inflation stays high, the Federal Reserve has more reason to keep raising interest rates and unfortunately for gold, high interest rates weigh heavily on it. You then add the strengthening dollar into the mix, which is supported by higher oil prices given its a net exporter of energy, and its no wonder gold pulled back as dramatically as it did.

By Monday morning, markets were putting roughly a 70% chance on another US rate rise in October. At the same time, the 10-year US Treasury yield climbed to around 5.25%, levels not seen for roughly two decades, which was just before the start of the global financial crisis. This creates competition investment wise for gold, as government bonds are considered relatively low-risk and at these levels, offer investors a yield of more than 5%. Gold, of course, pays no interest at all.

What is perhaps more surprising is where all of this started, with geopolitical uncertainty ordinarily expected to support demand for gold. But right now, the market appears more concerned about what the US-Iran conflict is doing to oil, inflation and interest rates than the uncertainty of the conflict itself. In other words, gold's traditional safe-haven appeal is currently fighting against the economic consequences of the very conflict that might normally support it.

Whilst Monday saw gold cave to interest rates and other associated headwinds, Tuesday, however, offered the some signs that the argument might not be quite so one-sided. US consumer confidence fell sharply in September, dropping from 88.6 to 81.9, its lowest level since 2014. Americans became more pessimistic about both current conditions and the outlook ahead. The labour market data also showed further signs of cooling, with US job openings falling to around 7.08 million in August, below expectations and down from July.

This weaker economic data could potentially be good for the gold price, as it may take some heat out of expectations for further interest-rate rises. If the US economy begins to slow under the weight of higher borrowing costs and expensive energy, the Federal Reserve faces an increasingly uncomfortable balancing act: continue raising rates to fight inflation, or risk putting even more pressure on an economy that is beginning to weaken.

This picture may gain further clarity this week with a series of follow up economic data. Wednesday brings private-sector employment figures alongside the Federal Reserve's preferred measure of inflation, the PCE index. Manufacturing data follows on Thursday before Friday brings the September US employment report. Each set of data could materially change expectations for what the Fed does next. If inflation remains stubborn and employment continues to hold up, markets could become even more confident about further rate rises, with that 70% estimate of a rise likely to climb higher. That would leave elevated bond yields and the dollar firmly in gold's way, potentially bringing the psychologically important $4,000 floor level into greater focus.

But if Mondays underwhelming economic data is continued by the other releases this week, then a cooling of inflation and holding interest rates becomes the topic of conversation ahead of Octobers interest rate decision. Monday's sell-off showed just how quickly gold can move when expectations around interest rates change, with this applying in both directions.

There is also one enormous unknown sitting outside the economic calendar: Iran. The Strait of Hormuz remains central to the outlook for oil, although further talks between the US and Iran are expected. Oil prices eased from Monday's highs on expectations that Qatari mediators would continue discussions with both sides. Progress there could ease pressure on oil and, in turn, inflation expectations.

That leaves gold caught between two forces that are usually considered supportive (economic weakness and geopolitical uncertainty), and right now they are pulling in different directions. Weak economic data could reduce expectations for higher interest rates and give gold some breathing room, but further escalation in the Middle East could send oil higher, keep inflation elevated and force the Fed to remain aggressive.

After Monday's fall, gold has already shown some signs of stabilising above $4,100. Whether that becomes the start of a recovery or simply a pause before another test lower could depend heavily on what this week's numbers tell us about the US economy. Last week, we were wondering how long gold could keep standing against its headwinds, where as this week, it's whether the incoming data gives gold a hand back up or another push towards $4,000.