Gold prices will be impacted by Fed moves, geopolitical scenarios and upcoming polls

In the last 12 months, gold prices in India went up by nearly 25% while the benchmark equity index Nifty 50 is up only 15%. However, the returns on gold investments in India, do not reflect the sentiments in the US market. While the US gold prices have increased in the last 12 months, it is trading at a broad range since it made its peak in August 2022. Since August 2022, the gold prices in the US have been gyrating between USD1,650 to USD1,850. Over the long period, two interesting trends emerge. From 2004 till now, Nifty50 has outperformed gold in terms of returns, whereas in the case of the US, gold returns outweigh equity returns. During the same period, gold has outperformed benchmarks like the Dow Jones Industrial Average as well as MSCI All Country Equity Market Index.The Fed has raised interest rates 11 consecutive times since March 2022. Gold is up 2.7% while the S&P 500 is down 3.6%. Interest rates, currency movements and the global economy affect gold prices. But are we so sure of that?105570870Gold has underperformed equities in India for around two decades. The Nifty’s returns were 13.51% and gold clocked 13% for the same period. On the other hand, S&P 500 has returned 7% (in USD) and gold returned 8.51% for the same period. Gold is considered to be a hedge against inflation and it is the “go to” asset during war or natural calamities. Long-term data shows that gold is a good hedge against inflation when real interest rates are positive. Over the long term, it generally rises during lower real interest rates and falls during higher real interest rates. Higher US interest rates often lead to a strong dollar and weaker emerging market currencies. This leads to rising gold prices as demand for gold increases in currencies that are weaker against the dollar. Now the US Fed drops hints that interest rates will soften. How will gold prices move from here onwards?Over the last one month, gold is up 1% (both in terms of US and Indian ETFs) while the S&P 500 is up 9% and Nifty 50 is up 3%. Let us not read too much into this short-term movement. The simple fact is that gold prices move depending on many factors it is difficult to predict and hard to value. Gold prices will likely continue to rise because it is becoming the go-to asset for investors who wish to have a diverse portfolio.105570865Among other commodity asset classes, the yellow metal started its run early in March 2020 from USD1,450 levels to USD2,080 levels till August 2020 – a rise of 44% within six months. In 2020, the economic and social uncertainties triggered by the COVID-19 pandemic turned the spotlight to gold as a safe haven. After that, it started its corrective move and took support at USD1,680 levels. Since then, it's been moving in a broad range.A point to note here is that in 2011, gold hit a life high of USD1,920-levels, and after nine years in 2020 with the trigger of the pandemic, it recorded a fresh high of USD2,075.The currency factorDespite its underperformance, gold prices are on a perpetual bull rally in India. In 2011, gold prices in India were around INR26,400, which continued to rise rapidly after 2017. It broke past the August 2022 high of INR 56,000 in January 2023 and hit a recent high of INR62,000.How did this happen?Globally, investors buy and sell gold with the US dollar as a benchmark. This means the value of gold is inextricably tied to the value of the US dollar. So, if the value of the dollar appreciates considerably, then the value of gold could also rise in tandem since it’s denominated in dollars (from an importer’s perspective).And that’s precisely what’s happening.The US dollar has been rallying like there’s no tomorrow. Currencies across the globe have lost value against the dollar. One year ago, INR78 would fetch you USD1. Today, you need to pay more than INR83 for that. Around two years ago, you needed only INR72 to buy USD1. In the last 10 years, the Indian rupee depreciated nearly 45% against the US dollar.And India imported a record USD55.7 billion in gold imports in 2021. In value terms, 1,050 tonnes of gold was imported in 2021. This means a higher outgo in rupee terms and a surge in import bill.Also, India has increased duties on gold imports from 7.5% to 12.5%. The weak rupee and the higher import duty have been responsible for pushing domestic gold prices higher. High gold prices and volatility also impacted jewellery demand as customers tend to wait for prices to settle down. A sharp jump in gold prices in October hit demand. “Obviously, more customers get spooked by this kind of sudden jump, especially post-October 10, when the present surge started. After the geopolitical tensions rose, we have seen a certain sluggishness. But having said that, in the last few days, there has been stability and most customers tend to wait till as late as possible before they jump into the festive buying. Overall, there has been some dampening (in prices),” Ajoy Chawla, CEO- Jewellery Division, Titan, said at its earnings call this month. 105570856105570855The valuation issueInflation is surging globally, and added to it are the geopolitical tensions following Russia’s invasion of Ukraine and the Israel-Hamas conflict.This seems like a wake-up call for ardent believers in the long-term promise of gold. The yellow metal is typically heralded as the perfect hedge against inflation. So, what’s happening? Has the hedge against inflationary fears failed?For conventional investors, valuing gold poses a problem. The precious metal does not generate a stream of income, since demand for it tends to be speculative, the cash-flow models used to work out whether assets are cheap or expensive cannot be applied.Also, the US has been increasing key interest rates to battle inflation and its bonds are offering attractive yields. So, as an investor, you can make gains by investing in these bonds as opposed to parking your money in gold.The bulk buyersApart from jewellery buyers, global central banks have been buying gold steadily to spruce up financial stability. Portfolio managers have also become big buyers seeking to diversify their asset allocation. “So, if you have got a 60:40 portfolio, spread your bets, think a little bit of positive allocation in terms of places where you have got good risk-reward,” Lori Heinel, Global Chief Investment Officer, State Street Global Advisors, said in a mid-November discussion with John Reade and Joe Cavatoni – Market Strategists at the World Gold Council.“We have looked for a diversifier, so gold continues to play a very prominent place in our portfolio. We've got about a 3% allocation which might sound small, but strategically we typically don't allocate to gold so that is actually a nice little hedge against both extremes. Frankly, you know a high inflationary environment or a deflationary environment. And so that will be a place we look sort of opportunistically to add some capital,” she said.The central banks are also beefing up their reserves and it seems like gold is still the preferred medium for that.As per the World Gold Council, net central bank buying of 337 tonnes in Q3 FY23 was the third strongest quarter in their data series. While the buying level was lower when compared with the exceptional 459 tonnes from Q3 FY22. Yet, demand from central banks YTD is 14% ahead of the same period last year at a record 800 tonnes. Q3 investment demand of 157 tonnes, although 56% higher y-o-y, was weak relative to its five-year average of 315 tonnes.Gold prices in dollar terms have been consolidating for the last couple of years Any breakout above USD2,100 levels will open further upside targets of USD2,500 levels. Indian gold prices will continue to rise more than the dollar due to early breakout in prices and the continuous fall in the value of the rupee against the dollar. A lot of factors will play a role in higher gold prices, including inflation, Federal Reserve moves, geopolitical scenarios, and even the upcoming US presidential election and general elections in India due next year.(Graphics by Sadhana Saxena)