Gold bounced higher Thursday from a six-month low as some traders covered short positions following the precious metal’s recent, sharp sell-off. But growing concern that inflation is pushing higher, possibly forcing the Federal Reserve into raising rates later this year are likely to limit any full-scale recovery.

August gold futures touched $4,046.20 on Thursday, their lowest level since November. Gold is down 6.3% this week alone, putting it on pace for a second straight weekly loss and its worst week since mid-March,  when gold fell 9.62%.

Fed rate decision

As a safe-haven asset, investors gravitate towards the yellow metal during times of market uncertainty and in hopes that it will act as a hedge against inflation. But because gold doesn’t yield anything, the metal is also especially sensitive to expectations for long-term, real interest rates.

The Iran war, now in its fourth month, has fueled inflation by pushing energy and other prices higher.

U.S. consumer inflation in May increased at its fastest pace in three years in May, mainly from the surging prices of energy-related products. Together with a stronger-than-expected May jobs reports, expectations have grown that the Fed may need to raise interest rates by the end of the year to slow down price increases. 

Next week, the Federal Reserve is expected to hold its benchmark lending rate steady at 3.50% to 3.75% during Kevin Warsh’s first meeting as Fed chair. A majority of ⁠economists in a Reuters poll expect interest rates to remain unchanged ⁠this year.

Traders less sanguine, and are currently pricing in a 67% chance of a Fed rate hike by December, according to the CME Group’s FedWatch tool. Higher rates, if they help stamp out inflation, can make dollar-denominated assets such as Treasury securities more attractive. 

“Gold is clearly significantly oversold just now and it remains to be seen whether this is a recovery as such or simply short positions taking profit,” independent analyst Ross Norman told Reuters.

The technical breakdown

Based on price chart analysis, the overall technical picture for gold remains weak.

Gold recently broke below its 200-day moving average for the first time since September 2023, which Citigroup flagged as a major negative signal. The bank has been cautious near-term on gold ever since the war escalated in March, partly due to higher energy costs springing from the closure of the Strait of Hormuz.

Long-term, Citi was more bullish, however. “Despite the negative near-term momentum, we expect gold price to eventually rebound when the Strait situation deescalates,” its analysts said.

JPMorgan is more pessimistic, saying retail and institutional investors have retreated from the so-called “debasement trade” based on a belief that the U.S. dollar would continue to depreciate. The bank cited outflows from gold exchange-traded funds and weaker futures positioning as evidence of the move, tied also to concern about the size of government debt, inflation and geopolitical risks.