The gold market ended last week on a bit of a weak note, as prices slumped by $5.60 per ounce in light holiday trade. As investors return to the financial markets this week, however, volumes could see an uptick as end-of-year positioning gets underway.

 

The next several weeks could see a significant increase in market volatility. The benchmark stock indexes have already shown an inability to hold a strong rally, and the CBOE’s VIX index recently staged an upside breakout on the daily charts. Unfortunately for stock investors, the markets could have a long way to fall before finding a long-term bottom.

 

One of the key drivers of recent market volatility has been the notion of rising rates. The Fed has already lifted its key interest rate twice this year and has one more hike ready to go next month. The Fed has also maintained its plans for another three rate hikes next year, although those plans are now facing some very serious scrutiny.

 

Although the central bank will almost certainly follow through with another hike at its next meeting, expectations now seem to be that the Fed will take a step back at that point and reassess its plans for next year. The central bank has faced a chorus of negativity surrounding its path towards policy normalization, and it seems more and more market participants from President Donald Trump to Mad Money host Jim Cramer are chiming in and voicing their opinions against further tightening from the Fed.

 

This criticism puts the Fed in an interesting spot. The central bank has gone out of its way in recent months to demonstrate its independence as it has asserted that further rate hikes are data-driven and remain appropriate. Recent stock market selling, however, might suggest that the Fed is moving too far too fast. Serious questions have been raised as to whether the economy can handle higher rates, and corporate valuations may need to see a much larger re-pricing given a higher cost of capital.

 

In other words, if the Fed does not back off on raising rates, recent declines in equities may be just the beginning of a much larger move lower.

 

Regardless of what the Fed does or does not do, the gold market seems to be in a position to benefit. Higher rates could send stock investors fleeing and could fuel significant risk aversion. This, in turn, could force a major asset rotation in which significant capital could find its way into gold and other perceived safe-haven asset classes.

 

If the Fed elects to hold off, or even decides to cut rates again, it could possibly buoy stocks but at the same time could fuel a major reversal in the dollar. The stronger dollar has been a major hurdle to higher gold this past year, and with that barrier removed the yellow metal could potentially see a swift and significant upside breakout. Resistance in the $1245 area remains the next upside target for the bulls.

The gold market is kicking off the new trading week on slightly weaker footing. The Veteran’s Day Holiday may keep many participants out of the markets on Monday, and price action may be dull.

 

This week, investors will once again have their hands full as they watch for any fresh economic or geopolitical developments. There are two themes in particular which may garner considerable attention: Rising inflation and falling crude oil prices.

 

According to an article from marketwatch.com, producer prices rose by .6% on higher gasoline and industrial supplies. This figure represents the largest increase in six years. The hotter than expected inflation data will likely force the Fed to continue on its current path of interets rate hikes. The central bank is widely expected to hike rates once more before the end of the year, and has penciled in another three rate hikes for next year.

 

The path of rate hikes had come under increasing scrutiny in recent months, as some key data pieces fell short of expectations and as the housing market continues to show some weakness. Even President Trump has gotten involved, making his opinion of further rate hikes very clear. The independent central bank does not appear likely to veer off its current course, however, and the PPI data is just one more reason that further tightening may be warranted.

 

The crude oil market is also another factor that could potentially shake things up. Oil officially entered bear market territory last week after dropping 10 days in a row. Such a straight decline had not been seen in the oil market since 1984.

 

Like copper, the crude oil market is often viewed as an overall barometer of economic activity. Recent price action would then seem to suggest that the global economy is not as strong as many investors think. In fact, the declines in oil could potentially be one of the effects of the ongoing U.S./China trade war. Copper has already seen major declines in recent months and appears poised for even more selling. In the current environment of rising rates and trade disputes, the combination of lower copper and lower oil could point to tougher economic times ahead.

 

China is one of the world’s largest consumers of raw goods and commodities, and the recent slowdown in the Chinese economy is certainly playing a major role in lower commodity prices. Chinese officials have already suggested various forms of action to prop up the world’s second largest economy. The question is will it be too little too late.

 

The dollar has benefited from the rising inflation data and the notion of further rate hikes. The greenback is trading at a 16-month high on Monday, and could see further gains as the week progresses. With recession and geopolitical risks on the rise, the stronger dollar appears to be the biggest hurdle to higher gold prices.

 

Gold is currently trading around a four week low, and could face a significant test in the sessions ahead. Following recent upside and a period of price consolidation, it is imperative for the bulls that the current dip is bought. The $1200 level could potentially find some buyers, and below that the previous swing lows around $1181-$1183 will need to hold. A break below those levels could potentially set the stage for a significant leg lower in the weeks ahead.