Gold prices have fallen although the Russia-Ukraine war continues to fuel geopolitical tensions. This has worried investors who saw the yellow metal as a safe haven asset. Here are some of the reasons for the fall:
Gold does well when the world is in trouble. Global gold prices climbed to a high of $2,070 an ounce on March 8 following Russia’s invasion of Ukraine on February 24.
However, gold appears to have taken a U-turn. Its price started to move down gradually and briefly went below the psychological level of $1,900 on April 25.
Apart from the war, other factors are influencing asset prices such as changes in interest rates, inflation and demand for gold jewellery and bullion.
Take the case of demand for gold jewellery. India and China are the two key markets for gold purchases. Many parts of China are under restrictions due to Covid-19. This is expected to severely depress demand for gold jewellery in the near term as shops are closed. If the situation persists and the incomes of potential consumers get compromised, then demand may remain suppressed for a longer duration. Low demand in a key market can pull down gold prices.
Expectations of higher interest rates can also push investors away from gold. When interest rates are near zero, there is little opportunity cost of holding gold. But as interest rates start rising, investors may want to shift to bonds from gold. Comments by officials of the US Federal Reserve have pushed bond yields and lowered gold prices.
“As we are approaching the May 2022 US Federal Reserve policy meet, market participants are discounting an aggressive rate hike trajectory for this year and hence we are witnessing pressure on the safe haven metal,” said Navneet Damani, senior vice president – commodity & currency research, at Motilal Oswal Financial Services.
Rising interest rates also triggered volatility in stock markets globally as funds flowed back to the US from various countries. The dollar index (DXY) – a measure of the US currency’s value against a basket of currencies – has climbed 12 percent over the past year to 101.6.
Megh Mody, commodities and currency research analyst at Prabhudas Lilladher, pointed out the negative correlation between the DXY and gold.
“Strengthening dollar on the back of hiking of interest rates by the US Fed in May is an important reason for the fall in gold prices,” he said.
Where will gold prices go?
Although expectations of sticky inflation, rate hikes and volatility in the stock markets are influencing gold prices, actual outcomes may be quite different.
A few months ago, the US Federal Reserve had emphasised that inflation was transitory in nature. However, going by its commentary in recent times, the US Fed is now worried about rising inflation and is keen to tame it.
“Markets have already factored in a 50 basis point rate hike in May, but now traders have also piled into bets that the US central bank will go even bigger in subsequent months in order to tame soaring inflation,” said Sriram Iyer, senior research analyst at Prabhudas Lilladher. “Gold could find support on the back of geopolitical and macroeconomic uncertainties, especially after recent speculation emerged that quicker-than-expected interest rate hikes could dent economic growth.”
This means gold may remain volatile as financial market participants watch how efforts to tame inflation by raising interest rates work out.
“Gold prices per 10 grams could trade in a broad range with critical support at Rs 50,000, followed by Rs 48,000 and Rs 46,500, while rallies on the upside towards Rs 55,000 would be opportunities to exit long positions,” said Damani of Motilal Oswal.
However, Iyer expects the range to be narrower. “Any dips towards Rs 50,400 will be met with buying. Similarly, domestic gold could face headwinds at Rs 53,000,” he said.
What should you do?
Volatile gold prices can offer some money-making opportunities to savvy gold traders. Experts advise against selling gold now just because prices have fallen.
Long-term investors should be guided by their portfolio’s asset allocation. Allocation to gold should be kept at 5-10 percent. This is best achieved by staggering investments in gold ETFs and sovereign gold bond funds.If gold prices shoot up too quickly, do not hesitate to rebalance your asset allocation.