Gold rally: What investors should do with the yellow metal

International gold prices notably suffered this year until October with prices closing at $1,636 per ounce last month, down 11 percent since the start of the year. Although there was a spike in March due to the Russia-Ukraine war, the geopolitical premium was short-lived and the prices had been on a downtrend since.

The drop in prices was a result of aggressive tightening by global central banks, especially the US Federal Reserve. The Fed started hiking interest rates in March and has taken the Fed rate to 4 percent to date from 0.25 percent in January. This has been the most aggressive tightening in the last four decades.

The Fed’s rate hikes caused yields on the benchmark US 10-year bond to rise above 4 percent, a level last seen in 2007, compared to just 1.5 percent at the start of the year. The higher yields made the dollar attractive for investors, resulting in the multi-decadal strong dollar with the US dollar index (DXY) above 114. All these factors contributed to a sell-off in gold, causing prices to fall considerably. To substantiate, global gold exchange-traded funds (ETFs) have recorded a net outflow of $2.2 billion year-to-date, taking total gold holdings down to 3,489 tonnes in October, the lowest since April 2020.

However, the market took a U-turn in November with a rally in gold and risk assets after dovish comments from Fed chair Jerome Powell where he hinted at a slower pace of rate hikes going forward, as well as favorable jobs and inflation reports for October. The Fed has been extremely critical of the tightness in the jobs market amid soaring inflation, and all the policy efforts have been directed to control them. The recent jobs report showed that the policy interventions by the Fed that started in March are starting to pay off.

The US added 261,000 jobs, which was significantly higher than the expected 200,000, even if the unemployment rate in October inched up to 3.7 percent from 3.5 percent in September. Adding to the ebullience was the inflation data on November 10 which showed that consumer price inflation declined for the third consecutive month to 7.7 percent year-on-year in October against the expected 7.9 percent. It slid below the 8 percent mark for the first time in eight months.

More importantly, even the core inflation that excludes volatile items like food and energy came in at 6.3 percent year-on-year against the consensus expectation of 6.5 percent. Therefore, it is reasonable to say that inflation has peaked and will continue to taper down given the base effect and the correction in global commodity prices. Investors cheered the inflation print and now anticipate a softer stance from the Federal Reserve. The expectation of rates went down considerably as seen in the chart below.

To that effect, the US 10-year yield is trading below 4 percent and the DXY corrected 6 percent this month to 106, taking gold up to a three-month high above $1,780.

Risk assets also rallied, taking the S&P 500 to a two-month high. On the domestic front, gold prices performed even better, rising 6 percent in the first 15 days of November alone with cumulative year-to-date gains of 10 percent.

Also read: What really moves gold prices?

It is now comfortable to say that the recent rally in gold and risk assets is on account of the anticipation that the Fed will be less aggressive from here. However, for the risk assets, there are still downside risks of recession and financial instability after the massive withdrawal of liquidity and interest rate hikes. For that matter, even the US 10-2-year yield spread has not shown any signs of reversal and continues to remain negative around 55 basis points, which is an indicator of an impending recession.

As seen historically, gold performs better than risk assets in times of recession, hence prices could move up further once we start seeing delayed effects of rate hikes on the economy and businesses. Also, when the Fed eventually pivots to stabilise economic growth, it could give a further boost to gold prices. Therefore, it becomes prudent for investors to hold 15-20 percent gold in the portfolio to protect their portfolio from market volatility and drawdowns, and even generate returns.