Progress on the vaccination front and improving macroeconomic situation has favoured risk assets and left gold sidelined despite favourable fundamentals. The metal struggled for most of July but regained those losses by the end of the month. Gold moved up by 2% to $1,815 levels with the backdrop of a dovish FOMC statement and weaker-than-expected US economic data taking a toll on the dollar. The US GDP expanded at a 6.5% annual pace in the second quarter, well below market expectations.
Fed in no hurry to taper
In its latest monetary policy announcement in July, the central bank left its benchmark rate unchanged in the range of 0-0.25% and would continue its $120 billion monthly bond purchases. Thus, no concrete timeline for tapering was declared, but markets are pricing it to happen in the first quarter of 2022.
The Center for Diseases Control and Prevention in the US changed its guidance to advise even vaccinated people to wear a mask in certain indoor settings. These developments have investors speculating that the Fed could loosen its stance if the Delta variant spreads rapidly in the US. This continued monetary support will prove to be conducive for gold.
Real rates on the decline
The 10-year Treasury yields in the US have moved down from 1.5% to 1.25% in July despite rising inflation and talks of tapering, taking the 10-year real Treasury yield to -1.15%. The price of gold has lagged in this drop in the real interest rates. So, gold seems undervalued from the fundamental point of view. If inflation is stickier than perceived, then the Fed and bond markets may be lagging, keeping real rates in the red till they catch up, benefitting gold. A decline in yields may indicate expectations of slower economic growth. Combined with high inflation, it could result in stagflation, conducive for gold.
In an ideal scenario, the Fed would taper asset purchases and and hike rates at the right time to keep inflation controlled while helping economic growth remain stable and robust. It’s more likely that the Fed will land up doing too much, too early, or too little, too late. In the first scenario, the economic recovery is negatively impacted. In the second, inflation worries come to the forefront. In both these scenarios, gold is set to benefit.
While fundamentals remain constructive, conflicting macroeconomic developments will keep gold prices range-bound in the near term. Investors should avoid going overboard and gradually build and maintain a 10-15% exposure to gold.
The writer is senior fund manager, Alternative Investments, Quantum Mutual Fund