Gold losing glitter

Gold is losing its shine. The precious metal, whose price neared a record high at the onset of the war in Ukraine, has come back to earth in the second half of the year after a string of US interest rate increases and a surge in the value of the dollar.

Benchmark gold futures prices in New York are at US$1,729 per ounce as of early October, down 15% from early March. At one point in late September the benchmark fell to US$1,626, the lowest since April 2020.

Gold's strength early in the year was a reflection of its reputation as a haven in times of insecurity. But its subsequent fall is exposing the close inverse relationship between demand for gold and dollar strength.

The fall in gold prices came on the back of accelerating US interest rate hikes. In September, the Federal Reserve raised the benchmark rate by 75 basis points (0.75%) for the third consecutive time. Since March, Fed has raised rates five times to tame inflation. 

The dollar index -- which measures the US dollar's strength against a basket of six influential currencies such as the euro -- soared to 114 in late September, hitting the highest in two decades. A strong dollar weighs on gold, as the yellow metal is often described as a "stateless currency" that investors buy when there is little trust in traditional currencies.

Furthermore, since gold earns no return for its owner, higher interest rates increase the incentive to switch from holding gold to holding dollars.

The Fed is expected to maintain its hawkish approach this year amid continued inflation. In August, the US Consumer Price Index registered an 8.3% increase compared to the same month last year, up from a market consensus of an 8% increase. In the September meeting, the Fed increased its year-end rate forecast to 4.4%, from the 3.4% it had previously expected in the June meeting.

Despite the headwinds for gold in the short term, analysts say the current price level is at the lower end and forecast a rebound next year. 

Itsuo Toshima, a Japan-based financial market analyst for Toshima & Associates, expects gold to range between US$1,800 and US$2,200 per ounce next year. "Amid persistent inflation, investors will soon start fretting over stagflation," said Toshima. He argued that even though inflation can somewhat be tamed, there is a limitation because some costs, such as rent, are unlikely to fall immediately.

Toshima expects the currently strong dollar to peak this year, as it lacks additional bullish factors for next year. "When there are no more bullish factors to strengthen the dollar further, the dollar index will reverse course to fall sharply," he added. 

Internationally, Citi is broadly bullish on gold, expecting prices to rebound above US$1,900 by mid-2023. Goldman Sachs in August forecast gold prices 12 months later at US$1,950. 

Amid continued uncertainty over geopolitical risks and the Ukraine war, gold market analyst Koichiro Kamei at Tokyo's Market Strategy Institute argues that there will be stable gold demand. The sharp fall in cryptocurrencies such as bitcoin on the back of US monetary tightening was alarming for investors, whereas gold prices remained relatively firm, Kamei added. 

The direction of gold prices is being closely watched in India and China, where demand for purchases of physical gold is traditionally strong. The two countries jointly account for around 60% of global demand for gold jewelry, bars and coins.

Ahead of Diwali, one of Hinduism's most popular festival seasons, which falls in October, demand for gold jewelry, bars and coins is expected to increase. The wedding season also comes between November and February, during which gold jewelry sells well. Analysts say despite the headwinds of a weak rupee, traditional demand for gold will still be strong. Gold prices are around 139,000 rupees per ounce as of early October, up 1.2% from three months ago, while gold prices in dollars fell 3% over the same period.

In China, the depreciation of the yuan is acting as a headwind for retail investors. In late September, the yuan plunged to the lowest level against the dollar since 2008. According to the World Gold Council, gold prices in yuan are 4% higher compared with three month ago.

Still, consumer demand for physical gold has little impact on international bullion prices, analysts say. The bigger determinant is how investors manage funds in the gold futures market while taking interest rates and the global economic outlook into account. 

Tatsufumi Okoshi, senior economist at Nomura Securities, expects the Fed to start cutting rates in September next year, a tailwind for the yellow metal, which yields no interest. "As fears over recession loom over and demand for safe-haven assets continues, we will see gold bounce back," said Okoshi.