scorecardresearchGold is a natural hedge but why has it failed to perform this year?

Gold is a natural hedge but why has it failed to perform this year?

Updated: 20 Sep 2022, 12:57 PM IST
TL;DR.
In times of economic uncertainty, major central banks tend to adopt an accommodative stance keeping interest rates lower to boost liquidity in the market.
India is one of the largest buyers and consumers of gold in the world.

India is one of the largest buyers and consumers of gold in the world.

Gold prices have been subdued this year, even as concerns over recession and inflation have persisted, which should ideally have supported gold prices.

Economic and market uncertainty are boon for gold prices as s weak outlook of the market makes gold more attractive for investors.

In times of economic uncertainty, major central banks tend to adopt an accommodative stance keeping interest rates lower to boost liquidity in the market.

Lower interest rates, additional liquidity, and slower economic activities boost safe-haven buying in gold on currency depreciation.

This has not happened this year so far. Data show that gold prices have fallen about 2% this year so far in rupee terms.

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Year-to-date gold price movement. 

Gold posted a robust gain of about 28% in 2020 when the coronavirus pandemic hit the world hard, halting economic activities. However, in the next year 2021, when the economic outlook improved, gold prices fell by about 2%.

5 factors that influence gold prices

Gold prices are influenced by factors ranging from macroeconomic indicators to government policies. Normally, gold prices are influenced by inflation trajectory, rate hikes, domestic demand and global factors.

1. Inflation: In times of high inflation, people tend to invest in gold as the yellow metal works as a hedge against fluctuating currency. Historical trends show that when inflation is high, the demand for gold increases.

2. Global factors: Global factors such as geopolitical issues, economic crisis and weak market sentiment boost gold prices. In such times, investors turn away from riskier equities and buy gold which is a safe-haven asset.

3. Domestic demand: It has been observed that gold prices rise during festive and wedding seasons due to increased demand in spot markets by jewellery makers. India is one of the largest buyers and consumers of gold in the world. A demand-supply mismatch during peak wedding seasons pushes gold prices higher.

4. Rate hikes: Rate hikes are bad for gold prices and vice versa. When rates go up, there is less liquidity in the system which means low inflation and stronger currency and bond yields. This erodes the appeal of gold as people turn to buying dollars and treasury papers.

5. Uncertainty in the equity market: When the outlook for the equity market is hazy and there is much volatility, gold as a safe-haven asset gains. Risk-averse investors avoid equities and invest more in gold simply because it acts as a hedge in times of uncertainty.

Why has gold failed to perform this year?

When everything is not well for markets and economies, why are gold prices not shining? There are two main reasons for that- one, economic recovery after the pandemic which triggered a profit-booking, and two, aggressive rate hikes by the global central banks.

Tapan Patel, Senior Analyst (Commodities), HDFC Securities pointed out that gold prices traded under pressure post-pandemic recovery as the reopening of global economic activities and large-scale vaccination lowered demand for gold compared to other asset classes.

"The rate hikes from US Fed and other major central banks while weakness in the eurozone economy have boosted buying in the dollar which is currently hovering near a 20-year high," said Patel.

Rahul Kalantri, VP of Commodities, Mehta Equities underscored that investing in gold is typically considered a hedge against economic uncertainty and inflation, as it retains its value while the buying power of fiat currencies erodes. But it becomes less attractive when interest rates rise, as investors do not receive interest or dividend payments for holding gold.

The outlook

Many analysts believe the rate hike regimes and gradual economic recovery may continue to weigh on yellow metal prices.

Kalantri highlighted that financial markets remain extremely volatile, making it difficult to predict accurately what the gold price will be in a few hours, and even harder to give a few days’ estimates.

"The developments in the US dollar, US real yields and central bank policy will continue to dominate gold prices for the remainder of this year. We are cautious about the gold market's outlook in the current interest rate environment. Gold will come under bullish zone only above 52,750 on MCX," said Kalantri.

Nirpendra Yadav, Senior Analyst, Swastika Investmart, said investors should add some quantity of gold to their portfolios as he expects gold prices to rise towards 53,000 levels for the short term while prices may test 61,000-67,000 in the long term. He said gold has support at 47,000.

Disclaimer: The views and recommendations given in this article are those of individual analysts and broking firms. These do not represent the views of MintGenie.

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Sovereign Gold Bonds (SGBs) are government securities denominated in gold with one gram as a basic unit.
First Published: 20 Sep 2022, 12:57 PM IST