Gold is back under pressure after a stunning surge. What's driving the dip?
Ever since the price of gold hit six digits – ₹1 lakh per 10 gm – back in April, the market's focus on the yellow metal has been intense. Traders and investors alike had bullish targets but, contrary to expectations, the price of gold cooled off in May. The bulls brushed this off as a normal correction, and sure enough gold was back above ₹1 lakh on 5 June.
However, there was a change in sentiment over the weekend, and the bulls don't seem very confident any longer.
Why is that? Let's explore the reasons for the recent dip.
Reasons for the correction
First things first. The price of gold hasn't fallen much – it's down only about 2% over the past two days. But sentiment has taken a bit of a hit, especially among traders. Reports that the price of gold may have made a temporary top are doing the rounds. This is not idle market chatter – there are genuine reasons for thinking so.
Also read: Gold duty evasion fight turns into a game of whack-a-mole
To understand this, you can read our prescient editorial from March – Will the gold rate decrease in the coming days? Here's the important part from the editorial.
When the entire market is talking about the rising price of gold, it's easy to forget that the opposite can also happen.
In that case, it would trigger losses for leveraged traders who are long on gold.
The factors that can cause a fall in the gold price are the same as the ones that are responsible for its rise… only in reverse.
Here's how...
Now, this doesn't mean that all the points above need to be fulfilled for the gold price to fall. Even some of these may be enough to take the wind out of the sails of the bulls.
As things stand, the bulls have the upper hand. However, investors should carefully watch out for any potential changes to the underlying factors driving up gold.
If the changes are sufficient in significance, then the price of gold will fall.
Some of the points mentioned above are indeed playing out. While there was a flare-up between India and Pakistan after we published this piece in March, the situation did not escalate and a ceasefire was declared.
While there has been an escalation in the Ukraine war, the markets are not too concerned about it.
On the other hand, there have been some factors that are putting pressure on the price of gold.
#1 US-China trade talks
Top trade representatives of the US and China are meeting in London today to work out a way to resolve the trade dispute between the two countries. If a breakthrough is achieved, stock markets will celebrate. This will reduce the demand for safe-haven assets like gold.
#2 US economy
One of the factors we mentioned that could put pressure on the price of gold was the chance of a US recession fading away. Gold tends to do well when there are fears of a recession. US GDP growth for the last quarter came in negative but that was due to tariff-related reasons.
If the US signs trade deals with major economies, including China, fears of a US recession will disappear. The latest jobs data from the US also suggests that the US economy remains resilient and that unemployment is not rising.
The US is a consumption-based economy. If the US labour market remains resilient, consumers will continue to spend, which in turn will prevent a recession. This is negative for gold.
#3 Delay in interest-rate cuts
Just a few months ago, financial markets were convinced that the US Federal Reserve would cut interest rates. This would be done, market pundits said, to prevent a rise in US unemployment and to head off a potential recession caused by Trump's tariffs.
Well, if US unemployment is not rising and the chances of a recession remain low, the Fed will focus on inflation, which has been stable in the US recently. Thus, it may not cut interest rates anytime soon.
Also read | Mint Explainer: What are RBI's final norms for loans against gold and silver?
Lower interest rates are bullish for gold. Gold doesn't pay an interest, so when interest rates rise, or are high, gold comes under pressure. The reverse is also true. If interest rates are falling or are low, gold tends to do well.
US interest rates are currently high and potentially still on the way up. In such a scenario, if the Fed does not cut rates, the price of gold loses a major reason to move up.
Conclusion
Does all this mean that you should sell gold? Certainly not.
At Equitymaster, we believe in having 5-10% of one's portfolio in gold at all times. However, investors should not see gold as a potential substitute for any other asset.
It makes sense to hold some precious metals in one's long-term portfolio, but it doesn't make sense to speculate on short-term price movements. If you're considering an investment in gold, you need to have a time horizon well beyond 2025.
Just because prices have gone up recently, it doesn't automatically imply that gold will either fall or continue to rise sharply in the short term, so do your due diligence.
Happy investing!
Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.
This article is syndicated from Equitymaster.com
Also read: Gold is sending markets a big warning signal
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