Posted On Monday, Jul 04, 2022
June was quite volatile with the push and pull of macroeconomic factors driving the prices of all asset classes. International gold prices fell by -1.6% m/m to close at $1,807 but held above $1,800 throughout the month on the back of macroeconomic and geopolitical uncertainty. The prices touched a high of $1,879 in the middle of the month after a knee-jerk reaction to the unexpectedly high US CPI numbers that touched 8.6% y/y in May. This was the third consecutive month where the inflation was more than 8% and the 15th month where the inflation numbers have stayed significantly above the threshold of the Fed’s 2% target rate. With inflation running high, investors started anticipating a faster pace of liquidity tightening and rate hikes which caused a swift correction in gold prices to $1,800 levels.
In the June FOMC meeting, the Federal Reserve increased the Fed funds rate by 75 bps to 1.5%, the largest increase in 28 years. The Fed Chair further indicated that there would be rate hikes of equal quantum, if necessary, to curb the rising inflation. This drastically changed the interest rate projections. Before the Fed meeting, February 2023 Fed Funds rates were projected to be less than 3%, which went up to 3.45% after the FOMC statement.
The aggressive tightening of the monetary policy led to a marginal fall in gold prices. However, the drawdown in the asset prices was more pronounced in equities and bonds. The S&P 500 fell by more than 9% last month taking the YTD fall to more than 20%, which is regarded as a bear market territory. On the other hand, a heavy selloff in the bond market was visible with the US 10Y nominal yield nearing 3.5% during mid-June, the highest after 2011. This led to the US 10Y TIPS yield touching 0.89%, the highest since February 2019. The rising yields propelled the flight of money to the US Dollar. The DXY, an index that compares the US dollar with a basket of currencies, jumped to a 20-year high of 105. A stronger dollar and positive real yields had a bearing on gold prices. However, the downside was capped because of risk aversion and a selloff in equities, persistent price pressures, and the geopolitical risk premium due to the Russia-Ukraine war.
That said, after the Fed’s extreme hawkish commentary, the recessionary concerns kicked in as investors feared the rate hikes could crash land the economy. The concern was evident in oil prices, which corrected by 6% in a month. Overall commodity prices also fell in June with the CRB Commodity index falling by 7% in a month. Fears of a slowdown were also reflected in the cooling of inflation expectations in the US and investors rushing into Treasury bonds. US 10Y nominal yield and US 10Y TIPS yield ended the month lower at 3.10% and 0.74% respectively.
Looking ahead, we expect gold prices to be rangebound and volatile in the short term as top central banks prioritize fighting inflation over growth, with another 75 bps rate hike expected in the US in July. However, in the medium to long term, we expect significant tailwinds to the gold price given that the global economic growth is expected to slow down meaningfully. The IMF has slashed the US GDP growth forecast to 2.9% from 3.7% in 2022. And when the US sneezes, the rest of the world catches a cold. An economic slowdown might compel the Central Banks, especially the Fed, to cut interest rates or reduce the quantum of hikes and abandon balance sheet reduction i.e pulling out liquidity. This would be a pivot from the current aggressiveness, pushing gold prices up. But given that the price increases are caused due to external shocks, there may be limits to monetary policy’s effectiveness. There is a likelihood that the global economy could enter several years of above-average inflation and below-average growth. This stagflationary environment, if materialised, will have destabilizing consequences for the global economy and markets, supporting investment demand for gold.
On the domestic front, INR depreciated by nearly 2% last month supporting the rupee gold price. Gold in the domestic market was flat m/m but up by 5% YTD. This is a massive outperformance compared to Nifty which is down 9% YTD. The positive sentiment with regard to gold was visible in ETF flows which were robust in May. While there was a net outflow globally, Indian gold ETFs recorded a net inflow of 200 crores in May countering global trends. Moving into July, the basic import duty on gold was hiked from 7.5% to 12.5% in a bid to temper imports of the metal. The immediate result of this move would be higher domestic prices.
Gold demand as an investment is gaining traction lately given investors have realised the relevance of holding gold in the portfolio in uncertain and volatile times. The benefit of currency depreciation along with the strong fundamentals of gold make it an excellent portfolio component to withstand volatility in the equity and bond markets, as well as whatever surprises are in store for the global economy going forward. Moreover, with efficient and convenient products such as Gold ETFs, it becomes easier to gain exposure to this important element of any Indian investor portfolio.
Sources: Bloomberg, World Gold Council
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