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Should Indian gold investors worry over US Fed’s rate announcement?

Gold prices have corrected over the last month or so. The dollar's strength and talks of rate tightening in the US are seen as the reasons. Should investors buy gold now?

June 25, 2021 / 09:16 AM IST

Gold prices have been volatile in the international market. In India, too, gold prices fluctuated quite bit. Spot gold prices declined from a high of Rs 49,400 to Rs 47,310 over the last three weeks. Many attribute the correction in gold prices to the news of US Federal Reserve’s supposed plans of raising interest rates in CY2023. Here is what you should know before you take any investment call on gold.

What has changed?

In its meeting on June 16, Governor Jerome Powell raised the forecast for both economic growth and inflation in the US. The Federal Reserve also projected two likely hikes in interest rates during CY2023. Earlier, market participants were factoring in hikes in interest rates only for as late as CY2025. This expectation of ‘tight monetary policy’ has come as a shock for many investors. At the same time, central banks in other regions such as Europe and Japan are not talking about interest rate hikes and instead harping on continuation of the accommodative stance – near zero interest rates.

What does that mean?

This announcement of possible rise in interest rates means that funds may be headed to the US from emerging markets. This in turn should strengthen the US dollar. A strong dollar leads to a fall in gold prices.

Close

There is one more reason why gold prices fell. Rising gold prices were an outcome of the rising investment demand for gold. Negative real interest rates – interest rate minus inflation – made many investors consider gold as an attractive option. If interest rates rise and inflation reduces, real yields may turn positive. If bonds start offering positive real yields, then the gold will have fewer takers and gold prices should head south.

Should you sell gold?

Some experts say that it is too early to talk about reversal in the direction of gold prices. “Though the US Fed has hinted towards hike in interest rates, it will still be behind the curve,” says Chirag Mehta, Senior Fund Manager-Alternative Investments, Quantum Asset Management Company. Put simply, the pace of increase in interest rate may be less than the increase in inflation over the medium term.

If the real interest rates remain negative for a reasonably long period of time, as Mehta expects them to, gold will continue to glitter.

Central bankers all over the world have unleashed a significant amount of liquidity to revive economies. Europe and Japan may still need further stimulus. Even in the US, the Federal Reserve has made it clear that it will continue with the asset purchase programme till growth picks up. In the medium term, inflation is thus expected to remain sticky, which will make gold attractive. Navneet Damani, Head Research-Commodities and Currencies, Motilal Oswal Financial Services expects gold to touch Rs 56,500 per 10 grams over 12-15 months.

Though gold prices are fundamentally poised for an upward move, investors must be cautious about their exposure. Going overboard on gold should be avoided. Invest up to 10 percent of your portfolio in gold, subject to your asset allocation.
Nikhil Walavalkar
first published: Jun 25, 2021 09:16 am

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