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.
