Fed decisions to set short-term direction for gold prices

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Gold prices in the international and domestic markets suffered losses in the first two months of 2024. A strong US dollar, expectations of further delay in US Fed rate cuts, and a rally in global equities affected the sentiment surrounding the metal.

The US Dollar has gained almost 3% since the start of January. Firm US economic releases and uncertainty over US rate cuts attracted investor attention to the US currency.

Hopes of US Fed’s rate cuts may significantly impact the performance of bullion. Since there is no direct relationship between US interest rates and the price of gold, changes in rates largely affect the value of the US dollar which is inversely correlated to gold.

Earlier there were forecasts that the US Federal Reserve may cut its rates as early as March, but the latest inflation data and cautious comments from the Fed officials indicate markets are scaling back expectations until June.

When interest rates are lower, the returns on dollar-denominated assets like bonds and savings accounts decrease. This can lead to a decline in the value of the US dollar relative to other currencies. Since gold is priced in US dollar globally, a weaker dollar makes gold cheaper for investors holding other currencies, which can increase the demand for gold and its price.

Also, gold does not pay interest or dividends. When interest rates are higher, the opportunity cost of holding gold is also higher. As interest rates fall, the opportunity cost of holding gold decreases, making it relatively more attractive compared to interest-bearing assets and potentially boosting demand for gold.Meanwhile, the broad fundaments remain healthy for the commodity. The escalating tensions in West Asia and ongoing Russia – Ukraine conflicts are raising concerns over the global growth outlook, offering support to haven commodities like gold.The forecast of the World Bank suggests the global economy is set for the weakest half-decade performance in 30 years. They also hinted that the global trade growth in 2024 is expected to be only half the average in the decade before the pandemic. Global economic uncertainty typically increases the demand for gold due to its safe-haven appeal and its special appeal as a hedge against inflation.

Looking ahead, gold in the international market may continue to hold inside a tight range. There are fewer chances for major rallies or liquidation in the immediate run. However, investors are waiting for critical US Central Bank decisions and global growth outlook to get a broader price outlook. Escalation of geopolitical crisis, performance of the equity markets, and central bank purchases are the other factors that can largely influence the short-term price direction of the metal.

On the domestic side, since gold prices are still at near record highs, there are chances of a correction possibly in the first half of 2024. Meanwhile, a weak INR and expectations of jewellery demand would offer downside support and hence it may preserve its positive outlook for the rest of the year.

Gold is one of the best long-term assets which offers both safety and decent return to its investors. Domestic gold prices have doubled in the last 5 years, and it surged more than 980% since 2003. Hence, investors can make use of every price correction to add the metal into his/her portfolio for longer-term benefits.

(The author is Head of Commodities at Geojit Financial Services)

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