Fed-induced volatility continues to be an overhang for gold

By: |
Published: October 6, 2015 12:04:41 AM

In September, the price movement of gold was largely focused on the US Federal Reserve policy. Initially, the markets were gearing up for a rate hike...

In September, the price movement of gold was largely focused on the US Federal Reserve policy. Initially, the markets were gearing up for a rate hike, which pulled down the price of the metal. The Fed, however, did not increase the rate, which helped gold recover some of the earlier losses .

But after the policy, Fed chief Janet Yellen said the rates could be raised later in the year. This again pulled down gold prices by -1.7% in a month.

In what could be termed as a dovish view, the Fed continued to delay normalising rates, citing inflation concerns and global economic and financial developments. It has now extended its concerns from domestic ones to focus on exogenous factors to justify the its easy policy. There’s always an underlying worry that a rise in US rates would pulverise emerging economies, which are precariously placed.

While Yellen’s overall tone was quite upbeat, she pointed to warning signs as well, which should keep the market guessing. It will add to the volatility at each new economic data set.

The Fed chief noted that “we cannot be certain about the pace at which the headwinds still restraining the domestic economy will continue to fade” and that “recent global economic and financial developments highlight the risk that a slowdown in foreign growth might restrain US economic activity somewhat further”.

Traders are pricing in a 41% chance the Fed will move in December and odds of 18% in October based on the Fed funds futures. We need to see a pickup in inflation expectations and lower market volatility to bolster Fed’s resolve to raise interest rates. Gold will continue to trade range-bound with a likely downward bias until we get the eventual rate hike.

At one end, the markets are trying to ascertain monetary tightening in the US. On the other, we are seeing other central banks trying to expand monetary easing conditions.

The European Central Bank plans to expand the scope of its stimulus programme by allowing officials to buy higher proportions of each euro area member’s debt. This will further strengthen the US dollar vis-à-vis other expansionist nation’s currencies and pressurise gold in turn.

Outlook for gold

The US rate increase still remains an overhang on gold markets. There is still a possibility of a rate hike in 2015.

While the Fed waits, liftoff remains long past due. It’s important to remember that rate normalisation, when it eventually does come, will be very deliberate and gradual.

Any signs of risk aversion can create turmoil in asset markets.

Markets are forward-looking and any rate hike has been well flagged. It would be surprising if expectations of US rate rise were not factored into the gold price. Until we get the rate hike, we expect the markets to remain range-bound with a downward bias.

Any delays on the rate hike could be supportive for gold. 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. After the initial rate normalisation jitters, the environment will likely be far more positive for gold and markets would shift focus to the likely nature and extent of rate hikes.

The Fed may not want to run risk of a divergent monetary policy than its global counterparts as it would lead to a significant appreciation in the dollar. Even the current dollar strength seems to be hurting the economy.

The initial increase in rates will start causing strains on the asset markets and threaten the anemic recovery, both of which have been a thriving on cheap liquidity. If there is further moderation of expectations rate increases, the recent downward pressure on gold should be alleviated.

As the market figures out that the Fed will stay behind the curve, gold should start moving northwards. What may move gold prices higher is the prospect of unwinding of short positions, which can be expected after the rate hike as the market will focus on the extent of rate hikes.

Until then, physical demand would support prices at lower levels helping limit downsides in gold.

Chinese demand may still remain tepid, but India could emerge as a strong buying support at lower levels. The main reason to own gold is that it is a good portfolio diversification tool and helps the investor reduce overall portfolio risk.

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

Get live Stock Prices from BSE and NSE and latest NAV, portfolio of Mutual Funds, calculate your tax by Income Tax Calculator, know market’s Top Gainers, Top Losers & Best Equity Funds. Like us on Facebook and follow us on Twitter.