Gold could lose more sheen as markets fear further US Fed rate hike

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Published: December 25, 2015 12:01:18 AM

Gold prices fell sharply this year to lows not seen since 2010. The current low in prices marks a fall of 11% this year and 46% from its peak in 2011.

Gold prices fell sharply this year to lows not seen since 2010. The current low in prices marks a fall of 11% this year and 46% from its peak in 2011. A stronger dollar, an increase in US interest rates and global deflationary forces have pulled down the price of the metal. There was lower demand for gold because of slowdown in China.

After the Fed rate hike, the markets will now be focus on the extent of rate hikes in the months to come. The Fed, while hawkish, is careful not to disturb the markets’ equanimity. Forecasts by the Fed of the future path of rates still imply a fairly steady upward progress.

Gold prices could be under some pressure in the short term as the market anticipates further rate hikes next year. Though, we anticipate downsides to be limited for gold from hereon. It is expected that Fed will not embark on an aggressive tightening until they see a risk of runaway inflation.

In either of the cases, Fed will stay behind the curve and do only little and keep real rates negative for much longer. Markets will continue to assess and re-assess the length of the tightening cycle creating volatility in gold and other asset markets.

It’s a matter of fact that the dollar strength is hurting gold prices. Dollar since its lows has risen by about 38% whereas gold from its peak has fallen by about 45%. Even this year, the dollar has gained about 9% and gold has declined about 11%.

Therefore it’s important to gauge how the dollar is likely to behave. 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. The overall in the US are now in decline and likely to record two successive quarterly declines.

In other words, the US conomy seems to be staring at an earnings recession. Fed’s own labour market conditions index change has been declining and approaching the zero mark. 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 as well.

Now, with most other regions of the world all engaged in massive QE and competitive devaluation of their currencies, a rate rise by the Fed now would only serve to cause the dollar to rise even further, leading to an even greater decline in profits. The widening policy divergence among major central banks is going to have a major impact on currencies and create the real potential for a currency war. Such an outcome would be incredibly bullish for gold.

So, beyond the short term, as the market figures out that 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 rate hike normalisation jitters as the market starts focusing on the extent of rate hikes which are likely to be restrained than many anticipate. Until then, we expect physical demand and central banks buying to support prices at lower levels helping limit downsides in gold.

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

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