There has been a sharp correction in gold prices after an unprecedented rally in the precious metals post the start of Russian military operations in Ukraine. The yellow metal was trading at US$1907 per troy ounce at the New York market on Wednesday evening, down $172 or 8.3 percent from its 52-week high of $2078/oz made on March 8, 2022.
In the Mumbai bullion market, on the other hand, the price of 24K or 99.99 percent pure gold is down 4.1 percent from a high of Rs 55155/10 gm on March 10 to Rs 52,885/10 gm on Tuesday.
This is one of the biggest retracements in the gold price in recent memory. In comparison, the yellow metal had corrected around 4 percent over the following six days after it reached a new high of $2121.7 on August 7, 2020.
The extent of volatility in the gold market suggests that the traders and investors are still a bit unsure about the future trajectory of the world economy post the Russia-Ukraine conflict.
While a sharp rally in the gold price in the last week of February and the first week of March was driven by a rise in global risk premium after Russian military intervention in Ukraine and the imposition of aggressive economic and financial sanctions on Russia by the US and its allies, the retracement suggests that traders believe that the worse effects of the conflict are behind us.
Not surprisingly, the sell-off in gold and other precious metals such as silver has been accompanied by a rally in risk assets such as equity.
The yield on 10-Year US Treasury bonds rose to 2.172 percent on Wednesday, the highest since May 2019 and up 49 basis points from the recent low of 1.68 percent made on March 6. Higher bond yield or interest rates put pressure on gold as it’s a yield-free asset, unlike bonds.
Some money also moved away from precious metals in the anticipation of a rate hike or lift-off in interest rates by the US Federal Reserve later this month.
The historical trend in gold price however suggests that the current sell-off provides a good entry point for long-term investors.
The long-term uptrend in gold that started in October 2018 at around $1250/oz remains intact and the price continues to remain in the same rising channel despite the recent correction. We should worry about gold only if the yellow metal closes below $1800/oz with a conviction. The gold market also continues to hold the medium-term uptrend that started in August last year.
The yellow metal is still up nearly 10 per cent from its August 2021 low and had acted as a good hedge against the volatility in the equity, currency and the bond market during the period.
Secondly, despite the short-term challenges and a return of risk-on sentiment in asset markets, structural factors like inflation, negative real interest rates and currency debasement — that were driving gold prices higher before the break out of the Russia-Ukraine conflict — remain intact.
The United States Consumer Price Index was up by 7.9 percent in February this year, the fastest pace of annual inflation in 40 years. Most analysts expect inflation to remain high for an extended period given a fresh blow to the global supply chain and a sharp rise in energy and commodity prices after crippling economic sanctions on Russia. This means that the real interest rate – nominal interest rate minus inflation – will remain in negative territory despite a rate hike by the US central bank.
Many analysts also believe that the economic uncertainty created by Russia-Ukraine provides the perfect opportunity for major central banks such as the Federal Reserve and European Central Bank (ECB) to slow down the pace of rate hike or even defer leading to even higher inflation and a further decline in real interest rate. This will be bullish for gold and other precious metals.
Gold prices will also be supported by fresh purchases by central banks in emerging countries as they diversify their reserves away from fiat currencies such as the US dollar and Euro.
Similarly, 45 percent of the world’s major pension funds reported investment in gold in 2021 up from 30 percent in the 2020 survey.
Gold accumulation by central banks and long-only funds is expected to accelerate further as the Western sanctions on Russia clearly shows that the global monetary & payments system and wealth have now been politicised and weaponised. This will trigger a shift away from the US dollar and Euro and fiat currencies in general for storing wealth and assets for the long term. Precious metals such as gold and silver are expected to be a clear winner here.
Also Read: How to invest in gold for maximum returns
According to data from the International Monetary Fund, central banks together had US$13.9 trillion worth of foreign exchange reserves at the end of December 2021. In comparison, their total gold holdings were worth only $2.1 trillion, nearly half of which is held by the United States and West European countries. Given this, there is a big headroom for emerging markets to raise the share of gold in their reserves. This will provide multi-year tailwinds to gold prices.
Long-term investors are advised to use this correction to accumulate the yellow metal. It’s a matter of time when the price will be above $2000/oz.
(Advice: This article is for information purpose only. Readers are advised to consult a certified financial advisor before making investment in any of the funds or securities mentioned above.)
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).