Gold Bounces on U.S. Dollar Weakness

Gold took a $35 jump after struggling to escape the $1,800 range, alongside strength in equities and cryptocurrency markets.

Key Takeaways:

  • If gold puts in a higher high on this rally, the price would be on its way regain June losses.
  • The U.S. Dollar Index dropped below its rising channel after the RSI divergence last week, giving gold a boost.
  • Companies are protecting their margins by passing higher costs to consumers. Despite record inflation, consumer demand for goods has also been rising.

Gold jumps out of the $1,800 range

Gold finally found some strength after lagging around $1,800 for most of July. The price jumped $35 in two days, mostly reacting to weakness in the U.S. Dollar Index. Dollar weakness increases foreign demand for gold because gold is priced in U.S. Dollars.

Despite the rally, gold has not yet risen above this month’s previous high of $1,832. To continue the stair stepping pattern, the price needs to put in a higher high and continue toward previous floors.

Same old, same old

Fed Chairman Jerome Powell announced that the Fed will keep purchasing government bonds and mortgage-backed securities to the tune of $120 billion per month. Although he said that the Fed was nowhere near raising interest rates, he did hint at scaling back asset purchases later this year.

Purchasing government securities and lowering interest rates are two of the Fed’s primary tools for increasing the money supply, therefore boosting the economy and inflation. When the Fed believes the economy has healed, they will reverse the COVID standard for ultra-loose monetary policy.

It remains unclear when that day will come, and how much inflation the Fed will tolerate in the meantime. Critics of ultra-loose monetary policy say the Fed has already set the U.S. on a course toward hyperinflation.

The U.S. Dollar Index seems to be holding up relatively well considering this risk. However, we must remember that the index only measures the strength of the U.S. Dollar relative to other currencies, not true purchasing power. In terms of purchasing power, most major fiat currencies have dropped significantly over the last year.

The cycle of inflation

As companies face higher costs for materials, they are testing how much inflation they can pass along to consumers. Companies must protect their margins without hurting demand, a careful balance that will play a major role in whether inflation is “transitory” or more permanent.

So far, U.S. consumers have not slowed their buying. New orders for durable goods (cars, appliances, etc.) increased 0.8% in June. Despite record price increases, consumers are accepting higher costs in restaurants, car dealerships, and grocery stores.

This could trigger a dangerous cycle. Consumer inflation expectations actually protect companies’ ability to raise prices. When consumers expect inflation to keep rising, they are less shocked by higher prices and more likely to keep spending money.

As inflation continues to rise, the purchasing power of U.S. Dollars continues to drop.

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