US Fed Reserve move on stimulus package holds key to gold’s direction

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Much has been written about gold in recent months, especially after the mid-April price meltdown when rates declined below the psychological $1,200 an ounce. However, in July and August, the market witnessed a rebound with the yellow metal gaining nearly $200/oz.
The importance of gold in developing economies is, of course, well known because of burgeoning jewellery demand. At the same time, demand for the yellow metal has been elevated by investors especially in the Western world who perceive it as a haven asset, hedge against inflation and portfolio diversification.
The precious metal’s investment status got further reinforced for over ten years from 2000 when it ensured double-digit returns to investors. A view now being widely held and constantly propagated by those with commercial interests is that gold prices will seldom fall and even if they did, they would rebound after some time.
This, of course, is make-believe and blatantly ignores market drivers. Because gold returned a mere six per cent in 2012 much to the disappointment of investors, and with equity markets beginning to rebound, there has been an exodus from the metal.
Currently, there are three key factors operating to impact the gold market prices. First is the widely anticipated tapering of bond purchase by the US Federal Reserve.
A fall in the rate of unemployment in the US to 7.3 per cent is a trigger. The next meeting of FOMC, scheduled for September 18, will be a crucial one that could signal the reversal of the Fed’s easy money policy.
If decision to reduce bond purchase is indeed announced, it would mean the beginning of the end of liquidity driven commodity price boom the world has witnessed for the last three years. Arguably, gold has been a major beneficiary of the Fed’s monetary largesse of recent years and a reversal would mean investors will flee the so-called safe haven asset.
With global economic growth showing positive signs of improvement – not out of the woods though – equity markets are beginning to come to life. Funds will likely flow from commodity gold market to equity markets. In the event of Fed announcing QE tapering, demand for the dollar will escalate and the greenback will inexorably strengthen.
A dollar rally will inevitably hurt gold’s price in dollar terms. To be sure, the dollar has remained somewhat weak over the last four months or so; but most currency experts are now bullish on the dollar. Of course, the same cannot be said about gold’s price in other currencies, for instance in terms of Indian rupees.
More recently, prices of two important commodities – crude oil and gold – spiked in the wake of geopolitical tensions surrounding Syria, in particular, and the West Asia North Africa region, in general. But it must be conceded that the price effects of geopolitical developments are usually short-lived.
Prices are sure to fall back when tensions ease. Gold is no exception. So, the gold market is faced with a situation where demand is weak – physical and investment.
Institutions have been selling the precious metal rather than buying. Central bank purchases are few and far between. Major importing and consuming countries such as India have imposed fiscal and other restrictions on gold imports.
The lack of investor confidence in gold’s ability to ensure a remunerative return is provided by the outflow of the metal from physically-backed ETPs. An estimated 400 tons have so far flowed out. So, the most crucial factor to drive gold prices in the next few days will be the Fed announcement. The dynamic of tighter monetary policy in the US together with continuing restrictions in major markets such as India is sure to pull gold prices further down from the current levels of around $1,400/oz. The market is most likely to end up below $1,300/oz, other conditions remaining the same.
Source: Hindu business line
Source:Bullion Bulletin

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