Gold prices set to rise further as Fed cuts interest rate

The global interest cycle is making a U-turn after rising for nearly four years. The United States Federal Reserve has announced an interest rate cut for the first time since 2020. Earlier this month, the European Central Bank cut its interest rate by 25 basis points. Interest rate cuts by the world’s major central banks are good news for risk assets and all eyes are on the equities and bond markets. Both these markets have done well during the year so far.

The US benchmark equity index, the S&P 500 is up 18 percent during the year so far, while India's BSE Sensex has rallied 15 percent since the start of the 2024 calendar year. Similarly, bond prices have rallied across the globe as the market expectation of interest rate cuts had resulted in a decline in bond yields.

For example, the yield on the US 10-year Treasury bond has declined by nearly 100 basis points in the last six months. Similarly, in India, the yield on 10-year government bonds is down by 30 basis points since April this year. This has fuelled a rally in bond prices as there is an inverse relationship between bond yields and bond prices. 

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However, gold has been the biggest winner of the reversal in the global interest rate cycle. The price of gold in the international market touched a record high of US$2600 per troy ounce this week and looks set to rise further. With this, the yellow metal has rallied 26 percent since the start of the 2024 calendar year beating all other risk assets by a long margin. (See the chart below)

Gold rallied one percent on Wednesday as US Fed cut its policy rate by 50 basis points (half a percent).

The price of gold in the futures market was $2620 per troy ounce in the New York market on Wednesday up from $2072 per troy ounce at the end of December 2023.

In a recent report, Goldman Sachs Research expects gold prices to reach US$2,700 by early next year buoyed by interest rate cuts by the Federal Reserve and gold purchases by major emerging market central banks such as India, China, Turkey and Russia. According to the brokerage, the precious metal could get an additional boost if the United States and European Union impose financial sanctions on countries like Russia. Gold is also expected to gain if investors worry about the USA's growing public debt-to-GDP ratio and its second-order impact on the country's public finances.

According to Goldman Sachs, gold is their strategists’ preferred near-term long (the commodity they most expect to go up in the short term), and it’s also their preferred hedge against geopolitical and financial risks.

“In this softer cyclical environment, gold stands out as the commodity where we have the highest confidence in near-term upside,” write Goldman Sachs Research strategists Samantha Dart and Lina Thomas in their report.

According to the brokerage firm, since the start of the Russia-Ukraine war in 2022, central banks have been buying gold at a brisk pace — roughly triple the amount prior. Goldman Sachs Research expects the buying spree to persist amid concerns about US financial sanctions and the growing US sovereign debt burden.

According to data from the World Gold Council, central banks purchased 310 tonnes of gold on a quarterly basis on average during the July 2022 to March 2024 period, against their quarterly net purchase of 119 tonnes during the January 2010 to June 2022 period. The War started in February 2022 triggering an avalanche of financial and economic sanctions on Russia by the US and its allies in Europe, Asia and North America.

This has created a strong demand for the yellow metal more than offsetting a weakness in consumer demand for gold jewellery.

Secondly, a rate cut by the Federal Reserve is likely to bring investors back into the gold market after largely being absent during the metal’s sharp rally over the past two years. 

Gold is a non-interest-bearing asset and a decline in interest rate lowers the opportunity cost of holding the metal.

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Thirdly, gold offers significant value as a portfolio hedge against developments such as tariffs and trade war between the world’s major economies, Fed subordination risk (i.e., the risk that its independence may be undermined), and US debt sustainability fears. Researchers at Goldman Sachs see around a 15 percent upside in gold prices under a rise in financial sanctions equal to the rise seen since 2021, and similar gains if mounting debt concerns spur US government credit-default swap spreads (a measure of creditworthiness) to widen by 1 standard deviation (13 basis points).

If this pricing model turns out to be true then gold price will easily cross US$3000 per troy ounce in the international market by the middle of next year. The gold prices in India would rise even faster as the yellow provides a hedge against rupee depreciation. The Indian rupee has been depreciating against the dollar at a steady pace since the 2008 Lehman Crisis.

The yellow metal is a good investment option right now.

(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist). 

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