Gold rally may be 'a little bit ahead of itself': Strategist

Gold (GC=F) has experienced a remarkable rally, delivering its best monthly performance since October, fueled by expectations of potential Federal Reserve rate cuts. However, Barclays Equity Derivatives Strategist Stefano Pascale joins Yahoo Finance Live to discuss why he believes gold's rise is premature.

Pascale highlights the impressive nature of the rally, noting its "persistence" and "strength." He points out that gold has had returns for nine consecutive days straight, marking one of "the highest up streaks for gold" in the past 50 years. According to Pascale, "there's something other than fundamental drivers" propelling the gains. The primary drivers of gold — yields and the US dollar — "should have only accounted for one-third of the rally that happened."

Pascale emphasizes that investors have already priced in the typical 10% rally that usually follows a Federal Reserve interest rate cut. While acknowledging the probability of "upside room left," Pascale argues that from a historical perspective, "the rally has already happened" in gold.

As an alternative investment approach, he recommends that investors consider options as a potential avenue to capitalize on the precious metal's movements.

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance Live.

Editor's note: This article was written by Angel Smith

Video transcript

- The gold's record rally isn't showing signs of slowing down, having its best month since October as investors gain more optimism around rate cuts to come this year. But our next guest says the rise could be premature. Stefano Pascale, Barclays equity derivatives strategist is joining us now. And Stefano, thank you so much for being here. I can't get over the performance that we're seeing of gold layered next to Bitcoin, because it just looks like they are exactly layered on top of each other, and one of them seems like a risk on vibe, and the other seems risk off.

Help me understand how this market is having both of those dynamics play out at the same time.

STEFANO PASCALE: Yes. So thank you for having me in the show. So, obviously, gold recorded really rally for the books. So the 7% rally that we've seen over the past month has been higher only 6% of the time over the past 10 years, right? But not to the extent of the rally really that's been impressive, it's also been, essentially, the persistence and the strength. So if you consider the gold that's been recording nine consecutive daily positive returns, that certainly happened a bunch of times in the past 50 years.

That's one of the highest up streaks for gold. And so the intensity kind of suggests that there's something else other than fundamental drivers sort of work here, and we do think that it sort of also linked to technicals. So, for example, if you look at the bonds rally and the sell off in USD, I mean, famously, the US dollar and yields are two mechanical drivers for the yellow metal. There were, obviously, some important tailwinds behind the rally in gold, but they do not explain the full story.

So, for example, our model shows the yields and the US dollar should have accounted for only one third of the actual rally that happened. So there's something else at work. Now, we did some positioning analysis, and, basically, there's a strong evidence that the Fed pivot sort of forced macro funds to switch from having a negative exposure to gold by positive exposure. In other words, sort of the prospects of the first cuts forced a lot of macro funds out there to cover their short positions, right?

Now, in a way, we think that the macro environment is supportive for gold. I mean, we do think that there's going to be a first cut in June. And if you look historically, gold has done pretty well around the start of a cutting cycle. However, we do caution a little bit here because we think that gold is running a little bit ahead of itself. So that's a very interesting stat that shows since 1980, gold tends to be muted ahead of the first cut.

In fact, he only rallies after the first cut has been already delivered.

- Yeah. So then--

STEFANO PASCALE: That's not the case right now.

- Yeah. Stefano, then how much is that already fully priced in, and then that also begs the question, if we don't get that rate cut when the market is expecting, are we actually going to see some downward pressure then on gold in the near term?

STEFANO PASCALE: Yeah. I think that's fair. So, obviously, part of the rally has already happened, which is why we are calling for caution. So, typically, the rally that happens after the start of the current cycle is about 10%. And so we're almost already there, right? There may be some more upside room left, but, you know, obviously, compared to history, a lot of the rally has already happened. So one thing you can do actually, instead of waiting for a better entry point, which is famously very hard to time the market, one alternative is to actually use options, right?

So, for example, the strategy that we are recommending is to gain upside exposure via call spreads. I mean, the strategy, obviously, the advantage is that for a price, it has some sort of insurance built in. So you have upside exposure, but you're not exposed to the downside. And right now, I think volatility markets are really giving you a really good entry point for that type of strategy.

- Stefano, we have less than a minute left here. I'm just curious, who is the buyer for gold right now? What is that profile looking like?

STEFANO PASCALE: If you look at the market through different segments of investors, it does look like retail investors have been absent from the recent rally, so we actually seen a lot of outflows from gold ETFs. On the other hand, macro funds, they switched from being short to now being long, and, obviously, the other big players are central banks, which have been big buyers now for many months in a row.