The rupee value of gold touched its record high of ₹59,233 per 10 gm on March 20, 2023, while crossing the ₹60,000 mark in its intra-day trading. However, some correction was noticed subsequently. In this context, the Bank of Baroda Economics (BoB Economics), in its report, has evaluated the factors that have driven gold prices historically.
Movement of the dollar holds the key, it noted.
"In general, an appreciating dollar puts downward pressure on gold ceteris paribus. In the current context, with dried-up liquidity and an ongoing banking crisis, the dollar index is unlikely to trade with an appreciating bias. The Fed has kept its statement cautious indicating that decisions will be data-driven. This indeed would push up gold demand with the safe haven factor coming into play. We expect an upside to gold price to persist and touching the US$ 2,000/troy ounce might be likely," said the report.
All in all, as an asset class, the inclination may continue to be towards the ‘good old gold’. The shimmer of gold might further pinch the core inflation number going forward, it predicted.
How gold prices fared historically
Tracking gold prices since 2016, the report observed that barring three periods, especially 2013, 2014, and 2015, gold prices have generally been on an uptrend. During these periods, the brokerage mentioned that the ultra-low US Fed rate (0-0.25 percent) coupled with stable domestic growth during the period in the region of 6.4-7.4 percent drove investors ‘risk on’ sentiment for the yellow metal.
It also pointed out that years of geopolitical tension and economic crisis had a direct impact on gold prices. For example, the report revealed that post the global financial crisis of 2008, gold price in rupee terms shot up by 31 percent, whereas in US$ terms it increased by 25 percent.
Also in 2012, post the political turmoil in Egypt, Libya, Yemen, and Bahrain, gold price in rupee terms rose by 31 percent whereas, in $ terms, it increased by 28 percent, it informed.
Further, post Covid-19 situation, it reported that gold prices skyrocketed. In rupee terms, the price increased by 33.4 percent and in $ terms, the increase was 27 percent.
Meanwhile, In 2023 YTD, again the uptrend is clearly visible. From an average of ₹50,964/10gm in CY22, the price has risen to ₹56,904/10gm, it added.
Now let's understand the key factors that led to a rise in gold prices during these crises.
As per the report, uncertainty with regard to global growth conditions, the ongoing banking crisis and its contagion effect, recently increased the safe-haven demand for gold.
Demand dynamics: As per the report, gold demand firmed up, especially the holdings of global central banks increased. Their share in total gold demand rose from 11 percent in 2021 to 24 percent in 2022. As per the World Gold Council report, major buying was from Turkey and China, it informed. Notably, in 2022, PBOC (central bank of China) reported it's first-ever increase in gold reserves, a phenomenon last seen in September 2019. Hedging against inflationary risk and geopolitical uncertainty may be cited as primary reasons for increased holdings, added BoB Economics.
Uncertainty in macro fundamentals globally: 2022 and 2023 YTD have been phases of volatility in growth prospects as rising inflation dilemmas grappled central banks globally. The report noted that a synchronized slowdown was observed for major economies such as the US, Eurozone, Japan, and China, adding that inflation through a major part of 2022 remained above targeted levels for major advanced economies. Financial conditions remained tighter with Fed, ECB, and BoE rolling back major stimulus undertaken during the Covid period and also hiking rates by 475, 350 bps, and 375 bps respectively in the current cycle. This was translated into higher borrowing costs globally and has increased safe-haven demand for gold, it stated.
Dollar and gold: As an asset class, gold prices exhibit a negative relationship with the movement of the dollar index. Since gold is denominated in dollars, any increase in dollars theoretically makes gold less attractive as an investment leading to a decline in demand. On most occasions, this negative relationship has held true. In fact in the longer series, since 2000 onwards, the correlation coefficient between DXY and gold price was -0.28. For a short-term series since 2022, the correlation coefficient was -0.76, observed the report.
Gold exchange-traded funds (ETFs) driving demand: The report also showcased that the outflow on gold ETFs has been reduced significantly in CY22. From an outflow of 189 tonnes, it was reduced to 110 tonnes. Even in India, the funds mobilized through gold ETFs are on an uptrend and a rise in gold price would further attract inflows in this segment going forward, said the report. In simple terms, gold ETFs are basically units denoting physical gold which may be in paper or dematerialized form. This is significant because in India there are several options for dealing in gold such as spot trading, gold bonds and futures markets where one can derive benefits that flow from gold as an investment.
The recent upsurge in gold is a risk-off sentiment and inclination towards safe-haven demand. The news of UBS buying Credit Suisse has heightened volatility in the market. In fact, for the past week, the apprehension of banking failure post SVB, First Republic Bank crisis, has caused a preference for gold, noted BoB Economics.
According to it, a lot will depend on how the dollar moves. A stronger dollar will work against gold. The Fed has raised the rates once again yesterday and it is still uncertain as to whether there would be a pause subsequently. This may help to retain the attractiveness of gold as an investment option, said the report.
It also expects the demand from India, China to continue.
"In China, some economic indicators such as retail sales, and fixed assets are holding up well. Also, the monetary stimulus will encourage demand. Meanwhile, in the case of India, macros are relatively well-placed compared to their global counterparts. Apart from this, in the coming months, seasonal demand for gold would persist. A resilient agriculture sector would also push rural demand for gold higher. In other words, the good old gold would persist and favoured as a major asset class which in turn will put upside risk to its price," explained BoB.