FxWirePro: Buzzing bulls in bullion space on US CPI – Hedge gold via CME longs

Short-covering rallies are observed in today’s precious yellow metal trades that stage a modest recovery from over 1-week lows after the US CPI data prints.

The inflation rate in the US edged up to 2.9% in June from 2.8% in May, matching expectations. It is the highest rate since February 2012. On a monthly basis, prices increased 0.1%, lower than 0.2% in May and forecasts of 0.2%. Prices of shelter, gasoline, and food made the main upward pressure. 

Gold price would usually be sensitive to US treasuries, the 10-year UST yield stood at 2.863 percent higher by 0.02 bps, while 5-year yield was 0.029 bps up at 2.769 percent. The yields rose on Tuesday after a weak 3-year note auction causing the yield to flatten further with the spread between U.S. Treasury 5-year and 30-year yields contracting to under 20 basis points. 

Everything all told that leaves us with the realization that in view of rising inflation risks the Fed will stick to its course and will hike its key rate another two times this year and two times next year.

Our bullish stance on gold is fundamentally a leveraged bet on the weakening dollar—an upside option with limited downside that we believe is highly likely to move into the money. Based on our historical analysis, in the unlikely event the dollar rallies through the late cycle (only 1 out of the last 6 cycles), the resulting gold losses were relatively tame (8%).

However, on the flip side, over the 5 cycles when the dollar weakened over the last quartile of expansion, gold prices increased over 40% on average even before the subsequent recession dynamics pushed prices even higher. This seems to be a relatively cheap upside option. The downside scenario looks both relatively unlikely on a historical basis and has only returned moderate losses when it did come about in the 1991 cycle.

Alternatively, the more likely upside scenario for gold has returned multiples of this potential loss. With our forecasts still calling for a resumption of a synchronized global growth and hence a resumption of the medium-term trend lower in the dollar, we consequently maintain our bullish view on bullion.

On hedging grounds, we advocate activating longs in CME gold contracts for Dec’18 delivery at $1,245.80 levels for arresting anticipated bullish risks upto $1,540/oz, while we have lowered our stop to $1,197/oz. 

Currency Strength Index: FxWirePro's hourly USD spot index has shown 67 (which is bullish after US CPI data) while articulating at 13:19 GMT.

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