What should gold investors do when Fed starts raising rates?

Spot gold has fallen more than 6 per cent since the end of 2020. Fading safe haven appeal and hopes of tapering of fiscal stimulus prevented gold from holding on to gains this year. However, rising inflation and the US Federal Reserve’s decision to delay hiking interest rates offered lower level support to prices.

Gold has tested an all-time high of $2,072.49 an ounce in August 2020. Since then, it has been trading in a tight range of $1,959-1,676 levels in the international market. Despite a weak rupee and surging physical demand, domestic prices also traded choppy with mild negative bias.

The precious metal started the year near $1,950 an ounce but concerns over investment demand pulled it down to $1,676 an ounce by March. Later, it continued on a tight range as traders continued to observe the impact of pandemic on the global economy and central banks’ policies on tapering monetary stimulus.

The US Federal Reserve started reducing the pace of asset purchases but indicated that it would not rush to raise interest rates this year. Earlier, the massive US fiscal stimulus package to support the virus-stricken economy boosted the prices of precious metals. Economic stimulus usually lifts gold higher as the metal is considered a hedge against inflation and currency debasement.

Investor sentiment also turned to equities and other risky assets as the Covid-19 pandemic was under control which improved global economic activities.

The Federal Reserve’s move on tapering of stimulus measures and surging inflation accelerated a rally in the dollar, which further limited the appeal of the yellow metal. Robust growth outlook and firm economic numbers further aided the greenback. A rise in US treasury yields also strengthened the US currency this year.

In the domestic market, futures prices shed about 7 per cent so far from when it was trading at Rs 51,875 per 10 gm, its highest level tested in January. Despite a weak rupee and increased physical market demand, prices were weighed down by uncertain overseas sentiments. Meanwhile, India continues to be the world’s second largest consumer of gold and imports continue to grow despite high import duty.

The outlook of gold for the next year is most likely to be sluggish. Prices may find support in the initial months, but a downward pressure is likely when the Fed starts hiking interest rates.

In the latest policy meeting, the Federal Reserve decided to end its pandemic-era bond purchase and has projected three rate hikes in the next year. Policy decisions from other major central banks would also influence the sentiment of the yellow metal.

In the changing economic environment, investors are likely to shift towards digital currencies as a store of value and inflation hedge, which may further dampen the safe appeal of precious metals. In addition, increased global economic activity, a firm dollar and easing pandemic tensions also put pressure on prices. However, a sign of a strong rebound in physical demand, especially in major Asian hubs may mitigate heavy liquidation.

On the technical side, prices remain constrained at $1,960-1,650 an ounce, but breaking any of the sides would suggest fresh directional moves. In the domestic futures market, stiff resistance is seen at Rs 50,050 per 10 gm and support is placed at Rs 43,200.

(The author, Hareesh V, is Head of Commodity at Geojit Financial Services. Views are his own.)