How much room does gold have to rise in this round of Fed rate cuts?

Industrial Research pointed out that with the Fed cutting interest rates by 125 basis points, the potential upper limit for London Gold could reach $2,657/ounce and $2,768/ounce, while the potential upper limit for Shanghai Gold could be 609 yuan/gram and 630 yuan/gram. Due to the weakening US economic data, the Fed's interest rate cut path is gradually becoming clear, and the current inflation decline suggests that the rate cut space may be between 75-125 basis points

Based on the current inflation decline, and referring to historical data, the potential interest rate cut space for the Federal Reserve is between 75 to 125 basis points. In the "Industrial Research Precious Metals Semi-Annual Outlook: Bull Market Continues, Restarting after Consolidation - Precious Metals Outlook for the Second Half of 2024 on 20240614", we calculated the gold price for the second half of the year based on the historical 75 basis points of the Federal Reserve's preventive interest rate cut cycle. The current market price is close to our calculated $2541 per ounce at that time. In this article, we will calculate the upper limit of the gold price if the current round of Federal Reserve interest rate cuts reaches 125 basis points.

In the scenario of a 125 basis points Federal Reserve interest rate cut, considering different Chinese bond rates, according to the model calculation, the potential upper limits for London Gold are $2657 per ounce and $2768 per ounce respectively. The potential upper limits for Shanghai Gold are 609 yuan/gram and 630 yuan/gram respectively.

Since the second quarter of 2024, with weakening US economic data, the path for a Federal Reserve interest rate cut within the year has gradually become clear. The current US economy is in the second inventory cycle of the economic cycle that started in 2020, transitioning from active inventory replenishment to passive replenishment, and a recession is still far away. Therefore, this Federal Reserve interest rate cut is most likely a preventive measure.

We have calculated that in different economic cycles, the Federal Reserve's sensitivity to inflation varies. Since June 2022, the US CPI has cumulatively declined by 6% year-on-year. Based on the sensitivity Beta of the Federal Reserve to inflation in different historical periods, the potential interest rate cut space may be between 75 to 125 basis points given the current inflation decline. Our calculation for the gold price in the second half of the year is based on the historical 75 basis points of the Federal Reserve's preventive interest rate cut cycle. In this article, we will calculate the upper limit of the gold price if the current round of Federal Reserve interest rate cuts reaches 125 basis points.

I. London Gold Outlook

In the "Industrial Research Commodity Report: Is the Gold Pricing Anchor Changing? - Discussion on the Relationship between Gold Price and RMB Interest Rates on 20240520", we stated that in the past two years, the impact of Chinese bond rates on gold has significantly increased. Since 2022, the response of London Gold to US bond rate fluctuations is still higher than its response to Chinese bond rate fluctuations. However, the full-time fitting coefficient has significantly increased after adding Chinese bond rates, so we calculated the situation after adding Chinese bond rates to the previous USD bond London Gold model.

Assuming a 125 basis points Federal Reserve interest rate cut, the US dollar index falls to 99, and the 10-year US bond yield falls to 3.3%. Chinese bond rates are fitted in two scenarios, one where the 30-year Chinese bond rate remains at the current 2.36%, and the other where it falls to 2.2%. In both cases, the upper limits for London Gold are $2657 per ounce and $2768 per ounce respectively. Technical analysis results also confirm the possibility of these two upper limits.

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Shanghai Gold Outlook

2.1 30-Year Treasury Yield Shanghai Gold Model

We still assume two scenarios for the 30-year Treasury yield: one is that the 30-year Treasury yield remains at the current 2.36%, and the other is that the 30-year Treasury yield falls to 2.2%. If the 30-year Treasury yield is at 2.36%, the corresponding upper limit for Shanghai Gold is 604 yuan/gram, and if the 30-year Treasury yield is at 2.2%, the corresponding upper limit for Shanghai Gold is 631 yuan/gram.

2.2 London Gold USD to RMB Model

If the US Dollar Index falls to 99, it may drive the RMB to appreciate to 7 or below. Assuming the RMB appreciates to 7, the upper limits of London Gold at $2657/ounce and $2768/ounce correspond to upper limits for Shanghai Gold of 609 yuan/gram and 633 yuan/gram respectively

2.3 China's Central Government Leverage Ratio Model

When China's central government leverage ratio rises to 25%, the corresponding upper limit of Shanghai gold is 592 yuan/gram. If it reaches 26%, then the upper limit of Shanghai gold would be 609 yuan/gram (24.6% in the second quarter of 2024).

Overall, in the scenario of a 125 basis point rate cut by the Federal Reserve, considering different ChinaBond rates, the upper limits for London gold are $2,657 per ounce and $2,768 per ounce. The upper limits for Shanghai gold are 609 yuan/gram and 630 yuan/gram respectively.

Authors: Xingye Research Fu Xiaoyun, Guo Jiayi, Source: Xingye Research Macro, Original Title: "Foreign Exchange Commodities | Revisiting the Space Above Gold"