Gold Liquidity May Remain Lower for Longer Amid Geopolitical and Monetary Uncertainty

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Written by Samer Hasn, Senior Market Analyst at XS


Gold fell slightly by less than 0.6 percent, trading near 4,040 dollars per ounce after a day that saw a recovery of more than 1 percent.
Gold may face a sustained liquidity crunch for an extended period as long as uncertainty remains and prevents the firm accumulation of institutional long positions. Prominent among these factors is the cloudy outlook for the path of conflict in the Middle East, which could expand again over the coming days or weeks, keeping upside inflation risks extremely high as the risk of targeting energy infrastructure in the region worsens. This limits sustainable investment flows into gold amid high interest rates and a preference for cash liquidity over weak purchasing power, particularly in the Middle East and Asia.
Oil futures continue to trade near recent highs, with West Texas Intermediate hovering near 101 dollars per barrel and ICE Brent trading above 111 dollars per barrel. This rise in crude prices comes despite the region's ability to restore crude flows to the global market to pre-war levels. Yet this divergence between prices and flows reflects the magnitude of underlying risks of a potential return to widespread supply loss. This in turn comes in light of several signals suggesting that renewed conflict in the Middle East may be inevitable and could involve a renewal of shocks such as those we witnessed last September when targeting the East West pipeline in Saudi Arabia. We still witness targeting of these facilities to date, with the Houthis in Yemen targeting the largest refinery in the Kingdom yesterday, which is Ras Tanura.
Not only that, but signs of a return to broader conflict that could include Iran, the United States, and Israel appear clearer than before. The United States notified several Gulf countries to prepare for an intense, short-term military campaign following the midterm elections, according to sources familiar with the Wall Street Journal. Officials also told The Journal that US forces are working to bolster their munitions stockpile and prepare bombers and fighters to launch strikes.
The dilemma here lies in that the decision makers of this war previously thought it would be short, fast, and capable of achieving its goals, and it seems this is what they hope for in the upcoming strikes, which could involve a miscalculation resulting only in an extended expansion of the war in time and space, worsening consequences globally and potentially leading to further waves of multi-front escalation as we saw previously. A former official in Israeli military intelligence told the Wall Street Journal: "I believe one of the biggest mistakes Israel and the United States continue to make is assuming that another round of strikes against Iran, including attacks on critical infrastructure or the elimination of senior officials, could somehow bring down the regime."
Furthermore, parliamentary elections in Israel are receiving widespread attention, as the composition of the new Knesset and understandings about forming the new government in the coming months could involve fundamental shifts in the paths of the multi-front conflict.
This narrative should reinforce upside risks for high energy-driven inflation. With the extension, this inflation could seep more broadly into wages and other goods and services, potentially keeping monetary policymakers more firmly attached to hawkish stances for an extended period amid prospects for continued interest rate hikes next year. This was reinforced by a recent Reuters survey, which found that 31 of 50 economies raised inflation forecasts for next year.
The market awaits the Federal Reserve decision today on interest rates and, more importantly, the expected speech from Chair Kevin Warsh following the announcement, which, according to CME FedWatch numbers, is likely to keep rates in their current range. However, fears of renewed shocks from Warsh's tone later today could help keep liquidity flows scarcer toward gold.
These combined factors of uncertainty, whether regarding the evolution of the conflict in the Middle East or elections in Israel and inflation prospects, could prevent gold from attracting sufficient liquidity to support a sustainable recovery, and could keep it vulnerable to quick reversals following any temporary, unsustainable gains. Liquidity scarcity was evident in the outflow of more than two billion dollars from the largest physical gold exchange-traded fund, SPDR Gold Shares, in the past week alone, and in the 20-day moving average of COMEX futures trading volume, which sits at its lowest level since last August.

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