Gold is a safe haven for many. For most, it is the first investment avenue that does not demand any pre-qualification or special skills. As opposed to this, equities or other avenues of investment require a certain amount of understanding to gain from it. But as global markets are interlinked tightly, there are certain intricate things that impact gold prices. Investing in gold is no longer an investment whose price functions in isolation or independent of any event or development. There are causes or developments which impact gold prices. Volatility in gold prices reflects the impact of developments that transpire not only around us but also far away from us. Recently, gold prices lost almost 30 points– from USD 1787 to USD 1755 per ounce. At times inflation in the US is high and China is dealing with the Evergrande crisis, historically speaking, gold prices should be rising. But it is not the case. Let us understand why gold prices are falling?
Gold prices are falling after they hit a high of USD 2073 on August 7, 2020. In the past year, initially, gold prices tracked open-up trade and vaccine discovery themes. As economic activities increased or resumed in various parts of the world—especially in developed nations— gold prices–a proxy to risk-off trade began to fall. Investors instead started chasing cyclical stocks which might have benefited from economic recovery.
Those who have been bullish about gold saw a ray of hope when the third wave hit the developed world – especially the US. However, by then, fortunately, vaccines reached a large section of the population which resulted in a low hospitalization rate and death rate. The fear of Evergrande default translating into a Lehman type of crisis has also not materialized. The Chinese authorities appeared to have stepped in. So, to put it simply, factors that could play a key role in the rise of gold prices have not transpired.
Also in the sixth meeting of the Monetary Policy Committee of 2021, which concluded on September 22, 2021, the US Federal Reserve kept interest rates unchanged. But it alluded to an increase in interest rate. It is expected to ‘soon’ start tapering the bond-buying program – which includes USD 80 billion of treasury bills purchases and USD 40 billion of mortgage-backed securities per month. The markets interpreted this as a hint that tapering may start as early as November 2021– when the US Federal Reserve meets to review monetary policy. The US Fed also made it clear that it would conclude the tapering process by mid- 2022. The talk of ending stimulus was enough to push up the dollar against all major currencies. The Dollar Index recorded a one-month high of 93.53. It must be noted that a strong dollar usually pulls down gold prices.
There is one more reason why gold prices turned weak. Though the US Federal Reserve is not clear about rate hikes, the first-rate hike is seen coming in late 2022. The key variable to watch out for is inflation. The real interest rates in the US and in most developed countries are negative as the rate of inflation is far higher than the rate of interest. Though the US Fed foresees inflation to stay high for some time, it expects inflation to trend lower the next year. By 2022 if inflation trends to 2.2 percent – which is near to the long-term goal of 2 percent, then the fear of negative real interest rates also goes away.
For the uninitiated, the negative real interest rates make many investors buy physical assets (including gold) to protect their purchasing power. High inflation-low interest rates (or negative real interest rates) simply destroy the purchasing power of a currency and is conducive for gold price
If the US Federal reserve manages to taper on time and economic recovery sustains, then most investors would not need as much gold in their portfolios. Probably the markets are pricing in this situation. However, there are risks to this: a nasty blowout in the Chinese economy – be it Evergrande or some other large default, rising geopolitical risks with Taliban in power in Afghanistan, slower-than-expected economic recovery worldwide requiring a further infusion of liquidity, worsening covid19 situation with some new variant and more than expected sticky inflation.
If you are wondering what you should do with gold in your portfolio, then here is the rule – stick to your asset allocation. Gold is cheap. But do not dump it altogether just because gold prices are falling. And do not take very high exposure to it anticipating a recession. The exposure to gold in a portfolio in a measured proportion should improve the risk-adjusted returns of the portfolio.