After the major earthquake, can gold reach new highs?

1. Rate Hike Trading: Piercing the Gold Speculative Bubble

Since March, gold prices have rapidly retreated, prompting market memories of the “Wash Trade” at the end of January. However, the January correction was driven by high crowding conditions and focused liquidations caused by expectations of balance sheet reduction. Before this round of sharp gold price adjustments, implied volatility had already moved away from extreme highs (Chart 1), with macro variables becoming the dominant factor.

The initial trigger for this round of decline was the outbreak of the US-Iran conflict, which caused a sharp rally in oil and the US dollar, leading to liquidity tightening expectations. As the world’s largest oil producer and net exporter, rising oil prices passively boosted the dollar against non-US currencies. Meanwhile, safe-haven demand from Middle Eastern and Asian markets also tightened offshore dollar liquidity. Subsequently, sustained high oil prices raised concerns about imported inflation, prompting central banks and futures markets to revise rate hike expectations. By March 23, the overnight swap market began pricing in approximately 0.8 rate hikes from the Federal Reserve this year, with the Bank of England, Eurozone, Bank of Canada, and Reserve Bank of Australia expected to raise rates 2.4, 2.2, 3.8, and 3.1 times respectively (Chart 4). The rise in US Treasury yields prompted speculators to withdraw quickly from gold (Charts 2 and 3).

2. Caution in the Short Term, Waiting for Volatility to Stabilize

In the short term, most technical indicators for gold show oversold conditions, but reversal signals are still unclear. As of March 23, the London Gold RSI dropped to an extreme value of 21.1 (Chart 6), but no bullish divergence has appeared; the K, D, J values are 13.6, 16.0, and 8.7 respectively, without a golden cross signal (Chart 5). Prices continue to probe below the Bollinger lower band, and the widening channel may signal the start of a new trend (Chart 7).

From an absolute volatility perspective, gold remains in a “high volatility” environment. Even after significant price corrections and the realization of many volatility expectations (IV-HV decline), implied volatility (IV) continues to rise (Chart 8), indicating increased uncertainty among options investors about future price paths, which still needs further market digestion.

Crowding and the gold-oil ratio both suggest that gold has overshot in the short term. As of March 23, short- and medium-term crowding levels are 0% and 21.5% respectively (Chart 9). On the same day, the gold-oil ratio fell back to 41, reaching the levels seen during the first major correction in August 2020, close to the long-term median (Chart 10).

From an cross-asset perspective, if gold can continue to reduce volatility, it will regain its safe-haven advantage. Since March, not only gold but major assets have been playing a stagflation trade, with stock and bond volatilities rising (Chart 11). The importance of cash assets is evident. Interestingly, cryptocurrencies—assets highly sensitive to liquidity and historically volatile—have fallen less this round, possibly because they experienced a prior decline, releasing valuation pressures early. After a period of decreasing volatility, gold may also regain its “relative safety.”

Below 4,500 points, 4,300 is the starting point for this year’s phase of gold and silver rally, while around 3,900-4,000 is both a psychological and technical support level, aligned with the 250-day moving average and last October’s gold correction (Chart 12). Falling below 3,900 could see support around 3,400-3,500, marking the beginning of the main upward wave in this cycle, similar to the shift in Powell’s monetary policy in August last year.

3. Recession Trading Might Be the Starting Point for Gold’s Rebound

Based on the experiences of the two oil crises in the 1970s, when the economy entered stagflation (high CPI growth + high unemployment), gold generally trended upward despite policy rate hikes (Chart 13). Data from the World Gold Council also show that when market expectations of stagflation rise, demand for gold remains positive on average (Chart 14). This cycle, however, saw a sharp correction driven by intense expectations adjustments, ignoring the underlying “stagnation” pressures.

It’s also important to note that the US economy is showing signs of weakness, with high oil prices potentially accelerating a recession. Unlike the stagflation of 2020-2021, when massive fiscal and monetary stimulus in response to the pandemic built excess private sector purchasing power—fueling inflation through supply and demand shocks from the Russia-Ukraine conflict—current conditions are different. Despite AI-related investments providing some support, the pain felt by lower- and middle-income households cannot be masked by AI investments. In January, US private durable goods consumption growth slowed to 1% (Charts 15, 16). For the first three quarters of 2025, AI-related industries contributed 37% to real GDP growth, higher than the same period in 2024, when real GDP grew by 2.1%; excluding AI, growth was only 1.5%.

The employment market also faces greater downside risks. As of March 2022, each unemployed person in the US was matched with 2.03 job openings; now, that ratio has fallen below 1 (Chart 17). The unemployment rate is nearly a point higher than in 2022. Non-farm payrolls increased by an average of 377,000 per month in 2022, but since June last year, the average monthly increase has shrunk to 3,600 (Chart 18). Additionally, layoffs in low-skilled jobs susceptible to AI automation remain a risk.

It can be said that before the US-Iran conflict, the US economy was already showing signs of “stagnation.” In this context, high oil prices trigger supply shocks, raising costs in transportation and logistics, squeezing corporate profits, causing factory shutdowns, and increasing unemployment. This could further erode household purchasing power, hastening the arrival of recession.

Under this scenario, even with oil prices remaining high, the Federal Reserve might reassess recession risks and consider the need for additional liquidity. Facing dual headwinds of economic stagnation and declining capital markets, the Fed could potentially cut rates again or expand its balance sheet to stabilize markets. This liquidity expectation gap caused by recession fears might lure some speculative gold investors back into the market.

4. Middle East War as a Sign of U.S. Power Decline, Brewing a New Bull Market for Gold

The US-Iran conflict is not ending soon; it may even become prolonged, which is unfavorable for dollar confidence.

First, regarding the US’s influence, NATO allies’ response has been limited, and the US, facing an opponent under four decades of sanctions, has not demonstrated overwhelming military superiority. In some areas, it has suffered asymmetric setbacks and exhaustion. In the short term, Trump failed to achieve the military overthrow of Iran or effectively protect Gulf allies, and finds himself in a dilemma. A decisive victory would be a success; failure would mean losing part of its Middle East influence and the dollar’s military-backed hegemony.

Second, Iran’s countermeasures—such as blocking the Strait of Hormuz—could, in the long run, undermine the “oil-dollar” link. For decades, Gulf countries have exported oil through the Strait, earning dollars that they then invest in US stocks and assets. This chain faces unprecedented uncertainties. If the US cannot regain control of oil pricing through the Strait or other means, the attractiveness of dollar assets to Middle Eastern capital will diminish.

Third, rising interest rates hinder the core goal of Trump’s second term—debt monetization. By February 2026, the average interest cost on US long-term debt was 3.38%, up 0.14 percentage points from a year earlier, with the lagged effects of high rates still evident. If the US expands military spending due to the conflict, accelerating fiscal disorder, the dollar’s credibility will further erode as markets price in these risks.

A new narrative favorable to gold will emerge. In the short term, the speculative liquidity bubble in gold will clear, making future gains safer. The dollar’s credit pricing often requires catalysts—such as the February 2022 “technical default” on Russia, the November 2024 “Hail Mary debt framework,” or the April 2025 “reciprocal tariffs.” The prolonged US military engagement in the Middle East is the fourth drain on dollar confidence. When markets start pricing in the decline of US comprehensive strength as a result of losing the Middle East war, gold will ascend to the next peak.

This article is from: Snow Tao Macro Notes

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