Are gold prices starting to show some signs of life?
Most analysts believe that the recent upside in gold is simply linked to changing interest rate expectations
Gold as an asset class has been forgotten and left for dead over the past few months. But after two bouts of a fall in prices—the first at the beginning of the year and then in the summer—gold prices are starting to show some signs of life. Not everyone is convinced it will last.
From the beginning of October, the price of gold gained about 7% until the middle of the month, before correcting marginally this week on technical selling. Still, gold prices are up 4.5% since the start of October and down about 1.5% since the start of the year. That would make gold a relative outperformer in the commodity pack so far this year. The broader basket of commodities, as measured by the Thomson Reuters CRB Index, a measure of different commodities, is down 15% this year. Commodities such as Brent crude oil (down 16%), copper (down 18%) and aluminium (down 19%) have all been hammered this year.
Still, no one is convinced that there will be any real and sustainable upside in gold.
Most analysts believe that the recent upside in gold is simply linked to changing interest rate expectations. At its September meeting, the US Federal Reserve developed cold feet about announcing its first interest rate hike in almost a decade. Since then, no one is quite certain how quickly the US Fed will raise interest rates. According to a 15 October Reuters poll of 90 economists, only about half of those surveyed believed that the Fed would raise rates at its December meeting. Earlier in the year, or even as recently as September, a far higher proportion of forecasters thought the Fed would announce its first rate hike in 2015.
It’s largely this changing interest rate expectation that has given gold a temporary boost this month. Higher interest rates are positive for the dollar, which in turn tends to be inversely correlated with gold and commodity prices. So, as the probability of interest rate hikes receded, the dollar index pulled back about 2.5% in the first two weeks of October, which coincided with the upside in gold prices.
But gold is a schizophrenic commodity, and if you dig deeper into why interest rate expectations are changing, then you will know why gold will not see a sustainable rise just yet.
Among the many narratives that have been linked to gold price movements, the yellow metal’s ability to retain value at times when inflation is eating into the value of paper assets, has been the most enduring. Essentially, gold is seen as a hedge against inflation. The lack of inflationary pressures across the global economy will prevent a sustainable upside in gold.
And that tells you why gold prices will see limited upside in the current global economic scenario. Global inflation, for all intents and purposes, is dead for now. Data from across the world, be it developed or emerging economies, shows that inflation remains low. According to the latest reading out of the US, seasonally adjusted consumer price inflation fell 0.2% in September, the second straight month of overall price declines. Inflation levels in the US remain well below the Fed’s targeted levels of 2% as measured by a different indicator, the personal consumption expenditures price index.
The story is similar in other economies. Inflation in the UK dipped into the negative in September for the second time this year, which could defer the Bank of England’s plan to raise interest rates. Euro zone inflation also turned negative the same month.
Even among emerging economies, inflation, for now, is a bit of a non-issue. For instance, in India, consumer price inflation is below the 6% target of the Reserve Bank of India that has to be met by the end of the year. At a recent meeting of the central bank’s technical advisory committee, members felt that global slack and expectations that lower oil prices will persist at least for another year will keep price pressures in check.
Given the prevailing view, which appears to be consistent across economies, it’s tough to see how gold will come into favour as an investment option. According to the World Gold Council’s August report, gold demand at the end of the second quarter of calendar 2015 dropped to a six-year low. Investment inflows into gold in the first half of the year remained weak due to the lack of upside in prices and also a preference towards risk assets. There is no reason to believe that will change unless there is extreme volatility across global markets.
In the absence of that, expect any rebound in gold prices to be shallow and short-lived.
Ira Dugal, assistant managing editor, Mint.
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