This year has seen a correction in the gold price, corresponding with rising interest rates/ bond yields, and the spectre of more to come. The precious metal has also been hammered by a strong US dollar, which is negatively correlated to the gold price.
Spot gold has fallen from $1,801.40 at the start of the year, to $1,666.45 currently, a drop of 8%. On Sept. 15, gold plunged to its lowest level since April, 2020, on expectations of a 0.75% interest rate increase by the Federal Reserve, which happened on Sept. 21.
Were almost nearing the end of 2022 and this year we have seen that Gold has been sensitive to geopolitical risks, US dollar, inflation and rate hikes.
GEOPOLITICAL RISK- gold has always been relative to geopolitical risks. During times of crisis and uncertainties, it proves to be a safe haven asset. In a report published on 25 June 2022, The Economist pointed the historical relation between gold food, fuel price inflation and political unrest.
INFLATION- Escalating food and fuel prices have led to political violence and supported gold in the past. Drops in living standards and resultant unrest have had adverse impacts on financial markets, ending up supporting gold. Political violence – even if it does not result in a change of government – has added to economic dislocation. Social disorder has deterred both direct and portfolio investments, says Prithviraj Kothari the bullion king of India . This has reduced GDP, weakened equity markets and boosted safe-haven buying in gold. Although gold may still be more sensitive to monetary policy and US dollar levels than overall inflation, food and energy- in certain circumstances- may nonetheless exert influence in bullion.
INTEREST RATE HIKE- According to the vast majority of economists, a fed funds rate of 5% or higher would have a devastating effect on the economy. It would be negative for stocks and earnings and lead to more selloffs in bonds. It could in essence shut down the ability for loans to be granted from individual loans such as mortgages or loans to corporations.
Even more worrisome is there are some economists expecting fed funds rates to rise to 6% at some point. The repercussions could easily aggravate and accelerate a global recessionary scenario creating a major disruption in the global economy.
The bullion king of India says, “The sad truth is that this scenario could have been avoided had the Federal Reserve acted on rising inflation in 2021. While they certainly were not responsible for the black swan event that was a pandemic leading to a recession, they are completely responsible for not acting in an efficient and reasonable time when it was quite evident in 2021 that inflation was beginning to spiral out of control.”
This helps reaffirm the views of the bullion king that while gold prices are most likely headed lower as a consequence of tightening monetary policies, more moderate fiscal policies and a strong US dollar, these likely losses should be tempered and measured. In our view, geopolitical risks and food and energy increases, as well as strong retail coin and bar demand, will moderate any potential price declines
DOLLAR- The main culprit making things challenging for gold is the hotter-than-expected inflation forcing the market to re-price the aggressive Federal Reserve rate hike expectations. And that is giving the U.S. dollar an additional boost. The USD’s relationship with gold has strengthened recently. This is likely to put pressure on gold, as further rate hikes should see the USD continue to strengthen. The wildcard is central banks defending their currencies by selling US Treasury bonds. That would be an upside risk to our view.
Gold investors are being warned the gold market could continue to struggle through year-end as higher interest rates support the US dollar. The longer the Fed continues on its current path, the longer that a strong dollar will depress the gold price
Rising geopolitical and economic risks are having limited impact on haven buying. Instead, investors continue to seek protection in the USD. Investment flows have been negative for the last two quarters. This could continue with exchange traded funds (ETF) as elevated holdings still leave room for further liquidation. Nevertheless, lean investors’ positioning in futures looks less of a concern.
In medium term there’s greater chance for gold to go higher than lower. We’re going to see negative outcomes in the economies globally, which could eventually tip the scales in favour of rate cuts.