Fundamental Analysis

Poor US Economic Outlook Could Favor Gold

  • US PMI shows a significant decline in business activity in July.
  • The US economy shrank by 0.6% in Q2, showing signs of a looming recession.
  • Gold futures prices could fall further if Powell is hawkish during the Jackson Hole meeting.

The latest Flash US Composite PMI from S&P Global is not encouraging for the American economy, so it could be favorable for gold futures (GC). According to the figure, the headline Flash US PMI Composite Output Index decreased from 47.7 in July to 45 in August. For the second consecutive month, the volume of all business activities declined.

US GDP & S&P Global US Composite PMI (source: S&P Global)
US GDP & S&P Global US Composite PMI (source: S&P Global)

The US is not the most robust economy in recent history, given the two-quarters of negative GDP growth.

What’s going on with the American economy, then? Why is production decreasing? Inflation and the Fed’s tightening cycle are to blame. Increases in interest rates and rising prices have diminished American consumers’ real disposable earnings. Corporate expenses were driven up by rising wages, transportation surcharges, and supplier costs.

According to a preliminary reading from the Commerce Department released on Thursday, the US economy shrank by 0.6% in the second quarter, less than market projections of a 0.7% decline. Economic activity has also improved compared to the initial estimate, which revealed a negative reading of 0.9%. We cannot, however, ignore the fact that the economy shrank.

Given the strong buying momentum it is experiencing, the gold market is not paying much attention to the rise in economic activity. As seen in the PMI data, the slowdown in business activity should benefit gold prices from a fundamental standpoint. It enhances the likelihood of a future Fed that is more dovish and takes us closer to stagflation.

At the moment, all attention is on the Jackson Hole meeting, which might cause a lot of volatility in the market.

“(Powell) is likely to focus on the short-term challenges and endeavor to leave no doubt about the Fed’s determination in the fight against inflation,” Esther Reichelt, a forex analyst at Commerzbank, said in a note.

“If he succeeds convincingly, he could support the dollar, at least in the short term.”

This would be bad news for gold futures which fall on dollar strength. The yellow metal could rise if the Fed Chair is more dovish than anticipated at today’s meeting. However, gold prices will decline if Powell gives a hawkish speech.