1. Gold prices may move up after Fed lift-off

Gold prices may move up after Fed lift-off

Gold has been out of favour this year and prices have come down because of the impending Fed rate hike.

By: | Published: December 11, 2015 12:18 AM
Gold prices

Gold prices ended at ,064.77 an ounce in November, a decline of 6.8% for the month. (Reuters)

Gold had been inversely tracking the probability of a rate hike by the US Federal Reserve in December. The price of the metal ended at $1,064.77 an ounce in November, a decline of 6.8% for the month. Fed chief Janet Yellen has described the rate increase in December as a ‘live possibility’ and even the minutes from Fed’s last meeting reinforced the possibility of a hike. While better-than-expected jobs data increased the odds of an interest rate lift-off, there are still some weak points in the US economy. Manufacturing PMI came in at 48.6 last month, which signals contraction. It was the first time in three years that the PMI came in at less than 50.

Gold has been out of favour this year and prices have come down because of the impending Fed rate hike. We’re back to the situation early in the year in the metals markets. This time around, there’s a hope that the Fed just gets over with it so that traders get a clear picture. The Fed minutes came out pretty much as expected, except that they suggested, if a rate increase were to be justified in December, the glide path for further rates would be shallow.

In the US, all through this year, earnings have been falling dramatically, barring the financial sector. Earnings for energy and metals companies have been the hardest hit. Earnings overall in the US have been in decline and are likely to record two successive quarterly fall. In other words, the US economy seems to be staring at an earnings recession. The strength in the dollar also seems to be contributing to this weakness. This is true not only because of a decline in earnings from uncompetitive exports, but also, with a strong dollar, consumers can purchase imported goods more efficiently. While most other regions of the world are engaged in massive QE and competitive devaluation of their currencies, a rate rise by the Fed now would only make the dollar rise further, leading to an even greater decline in profits. In short, with a strong dollar, the US is importing deflation, and in the process, hurting corporate profits.

The more important dynamics for gold remain the larger global growth challenges. With other major economies in easing mode, the Fed’s limited ability to aggressively hike rates will highlight gold’s appeal as an important allocation, as central banks embark on further experimental easing measures.

We expect the headwind for gold to ease noticeably in months following the Fed’s first interest-rate hike. When the rate hike happens there could be initial panic selling in gold on the prospects of further hikes and all talks of real rates moving higher. However, the downsides could be limited as the Fed guidance is likely to be dovish as it will have an adverse impact on asset markets. After the initial rate normalisation jitters, the environment will likely be far more positive for gold. It is thereafter markets would shift focus to the likely nature and extent of rate hikes.

As the market figures out that the Fed will stay behind the curve and do only little and keep real rates negative for much longer, gold should start moving northwards. What may propel gold prices moving higher is the prospect of unwinding of short positions which can be expected post the Fed rate hike as the market starts focusing on the extent of rate hikes which are likely to be restrained than many anticipate.

Until then, physical demand and central bank buying to support prices at lower levels will help limit downsides in gold. Even the global environment continues to remain positive for gold with the backdrop of low growth and deflationary pressure which the central banks are trying to resist with unconventional monetary measures.

One of the reasons to own gold is just the sheer fact that it is one of the good portfolio diversification tools, which helps an investor to reduce the overall portfolio risk.

ALL THAT GLITTERS

* Gold has been out of favour this year and prices have come down because of the impending rate hike by the US Federal Reserve
* What may propel gold prices higher is the prospect of unwinding of short positions which can be expected post the Fed rate hike
* The more important dynamics for gold remain the larger global growth challenges. With other major economies in easing mode, the Fed’s limited ability to aggressively hike rates will highlight gold’s appeal

The writer is senior fund manager, Alternative Investments, Quantum AMC

Tags: Gold Prices
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