From a fundamental perspective, the gold market’s trajectory in the current trading year will likely depend on developments in central bank interest rates (particularly related to the risk of a recession) and the geopolitical situation.

On the interest rate front, financial markets are currently pricing in five to six U.S. interest rate cuts, which would potentially bring the Fed Funds Rate down to approximately 3.75% to 4.00%. Consequently, yields on 10-year U.S. Treasury bonds have decreased by almost 25%, dropping from around 5% to 3.78% within just two months since October 23rd. Such a high volatility in bond markets is rare and could prompt some institutional investors to increase their allocation to the safe haven of gold.

Inverted US yield curve forecasts a recession.

US Yield Curve inverted, as of January 11th, 2024. Source: Barchart

Lower interest rates and a consequently weaker U.S. dollar would be beneficial for the gold price, of course. However, the Federal Reserve (FED) is likely to make such significant rate cuts only if there is a genuine risk of a severe recession and a substantial decline in stock prices. The current yield curve spread between the 10-year and 3-year U.S. Treasury bonds indicates this possibility. Historically, whenever this yield curve inverted and turned negative, a recession followed. If it happens again this time, gold and silver prices, along with beleaguered mining stocks, may experience a more than noteworthy moment due to the necessary interest rate cuts.

Geopolitically, the already complex situation has intensified since the brutal Hamas invasion in Israel. However, critical voices against Israel have been increasing, with the South African government filing a genocide lawsuit against Israel at the International Court of Justice on December 29th. The duration of the Arab world’s passive observation of the potential genocide in the Gaza Strip is difficult to estimate. Russian President Putin was welcomed with high honors in both the United Arab Emirates and Saudi Arabia in early December, though.

The Red Sea’s inflation threat

Meanwhile, in Yemen, Iran-supported Houthi rebels have expressed solidarity with the radical-Islamic Hamas in the Gaza Strip and repeatedly attacked container ships off their controlled coast. Hence, shipping companies such as Maersk and Hapag-Lloyd avoid the Red Sea. Consequently, freight rates have surged, and travel times have extended by approximately seven to 20 days. Due to the disruption in its supply chain, electric car manufacturer Tesla had to halt production in Grünheide near Berlin for two weeks starting at the end of January.

Shanghai to Rotterdam Container Freight Benchmark Rate. Source: Holger Zschäpitz

After the British-American air strike against Houthi targets in Yemen early Friday, the Houthis have pledged a big response. As about one-third of global container freight is shipped through the Egyptian Suez Canal and the Red Sea, further Houthi attacks could lead to new inflationary pressures or shortages due to supply chain disruptions. This geopolitical development contrasts with the expectations of interest rate cuts and doesn’t account for a potential escalation of the situation.

In the election year 2024, the U.S. government cannot afford escalation in the Middle East, Ukraine, or Taiwan, nor can it afford a recession in the U.S. economy. On the other hand, the Eastern bloc comprising China, Russia, and Iran will exploit any weakness in the U.S. The delicate balance between high interest rates and inflation control on one side and a weakening or recessive U.S. economic development on the other will continue to pose huge challenges for the Federal Reserve Bank. In this highly complex setup, Gold will most likely act like the canary in the coal mine.

It’s notable that the gold price consistently gains a few U.S. dollars almost every night during the in Asian trading session, while it is often trimmed back after 14:20 UTC in Western paper markets.