Posted On Thursday, Mar 10, 2022
After months of range bound price action, gold garnered strong buying interest in February touching over one -year highs of $1970 before settling just above $1900, ~8% higher for the month. Domestic prices aided by rupee depreciation moved up by ~10%. The rally was a result of risk aversion fueled by firming inflation and geopolitical tensions.
The Omicron wave and its economic fallout in an already slowing economic momentum as “handouts”- driven demand abates, has led to global economic growth screeching to an 18-month low in January 2022. The JPMorgan Global PMI dropped from 54.3 in December to 51.4 in January, its lowest since July 2020. An easing of Covid-19 restrictions around the globe should help revive the growth, though other headwinds like geopolitical tensions, high inflation, aggressive monetary tightening could outweigh this boost.
After a lot of back and forth, Russia launched a full-scale military invasion of its neighbor Ukraine in the last week of February. This resulted in a sharp sell-off in risk assets like equities and cryptocurrencies as investors rushed into gold, the US dollar and US Treasury bonds. While financial markets will remain vulnerable to developments on the geopolitical front in March, the impact could be short-lived if it does not blow up further involving other nations. Once the uncertainty eases, the fear-trade in gold prices can be expected to sober down and reflect their macroeconomic drivers such as real interest rates, inflation and economic growth.
However, in the event of this conflict getting extended or escalated, we are looking at more borrowing and money printing to fund military actions which could devalue debt and money. Economic sanctions against Russia, a major supplier and exporter of energy, metals and grains could hit global supplies and fan the fire of already high inflation, taking a further toll on global growth and spurring market volatility.This possibly stagflationary environment will be supportive of gold prices but will eventually clash with the Fed’s tightening cycle, which is expected to keep gold prices in check. The Fed has been behind the curve and further firming of commodity prices will lead to a more catching up on their part rather than real tightening. The slowing growth will test the Fed’s resolve to tighten liquidity and hike rates. Any U-turn in their stance will be a big win for gold.
Looking at the bigger picture, the Russia-Ukraine war marks a new order in international politics and has complicated things on the macroeconomic front for global policy makers just as they were putting Covid-19 behind and beginning to focus on slowing inflation without crash landing their economies. Especially since the Ukraine crisis kicks off a new superpower struggle among the US, Russia and China which could result in China following Russia and repeating Ukraine in Taiwan. Thus, one cannot rule out a geopolitical risk premium that gets built into gold prices. Also, there is a limit to sanctions the world can put on Russia without hurting itself, given Russia’s critical role in global commodity markets. The resulting volatility and uncertainty will keep gold relevant.
A bunch of interesting data came in from the US economy in the month. US consumer price inflation in January rose by 7.5% YoY, the sharpest rise since the early 1980’s. Concerns about inflation led US consumer confidence to fall to the lowest in 5 months. This increased expectations of a super sized rate hike by the Fed in March, only to temper down after less hawkish than expected minutes from the January FOMC meeting which mentioned flexibility in implementing policy exit given the highly uncertain environment.US treasury department data showed that the total public debt outstanding as of January was $30.1 trillion, nearly a $7 trillion rise since January 2020. The debt milestone is concerning given the transitioning US fiscal and monetary policy which will increase borrowing costs in the midst of delicate economic and geopolitical circumstances. Inflation and payroll data for February will come in before the mid-March Fed meeting and will play a crucial role in the central bank’s decision making.
Also weighing on Fed’s March policy announcement will be the Ukraine invasion and its consequences for the global economy. The Federal Reserve has in the past delayed major policy decisions in times of geopolitical uncertainty. While high inflation suggests a need for faster tightening by the Fed, the chances of a 50-basis-point interest rate hike in March have lowered.
Apart from the global developments, Indian markets also digested the growth-focused Union Budget 2022-23 and a surprisingly accommodative Reserve Bank of India policy in February. Inflationary monetary and fiscal policies combined with elevated global oil and commodity prices could cause a spike in domestic inflation. This will be supportive of gold demand as investors strive to keep up with inflation. A flight of capital from India due to a widening current account deficit and tightening global financial conditions could put downward pressure on the Indian rupee, which will be conducive for domestic gold prices.
While tightening of financial conditions is fundamentally negative for gold, there are multiple risks on the sidelines which, if materialized, can help those with a strategic portfolio allocation to the metal to better navigate financial markets in these uncertain times.
Sources: Bloomberg, World Gold Council
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