2011-02-25

Only at $1,440 we would start considering gold overvalued

We've seen a large jump in inflation expectations since the start of the week on the back of higher oil prices. Since Monday, 1y US breakeven inflation jumped 30 bps, to 2.37%. At the same time, implied real interest rates in the US declined substantially, well into negative territory once again. Given that
  1. Inflation until now remained largely absent in the US, and
  2. The US Fed doesn't target inflation explicitly, the likelihood of the US raising nominal rates remains small.
In fact, the probability the futures market assigns to a rate hike of 25 bps by year-end has declined in recent weeks, from 36.8% at the start of January, to only 25% yesterday.
Given that the Fed looks at inflation and employment, we read the decline in probability of a rate hike as concern over growth — much of this comes on the back of a rising oil price. These growth concerns could continue to weigh on industrial metals until crude oil settles down. Putting Middle East risks (which no doubt are supporting gold, too) aside, the rapidly declining real interest rate is bullish for gold. We believe that gold remains a buy on dips. Only at $1,440 we would start considering gold overvalued from a fundamental perspective.

Gold support is at $1,399 and $1,387. Resistance is at $1,420 and $1,429.

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