Why gold price move ?

Why gold price move

It is said that gold is an Inflation hedge. Whenever Inflation goes up, Gold prices go up. But if you look at the historical data points, Gold has not really been able to live upto the expectations.

(Q1) What really moves gold prices?

It’s not just inflation but a combination of Inflation & Interest Rates that moves Gold prices. Real Rate of Return like we call it moves the gold prices.

(Q2) What is a real rate of return?

Real Rate of Return in simple language is, Interest Rate – Inflation. If bank FD is paying you 5% & inflation is 6%, your real return is 5% - 6% = -1% & if inflation is 3%, your real return is 5% - 3% = 2%

(Q3) What’s the relationship between real rates & gold prices?

(a) Negative Real Rates (-1% in the above example) is supportive of gold prices

(b) Positive Real Rates (2% in the above example) works against gold prices

(Q4) Why?

(a) Gold is a non interest-baring instrument i.e. does not pay any fixed interest. 

(b) Hence, whenever rates drop, you make less fixed interest by investing incremental money in fixed income & hence it moves to Gold & When rates go up, you want to invest incremental money in Fixed income & not gold

(c) Hence, assuming inflation to be constant, you will invest more in Gold when Interest is 4% & inflation is 6% = -2% real rate and you will invest less in Gold when interest rate is 7% & inflation is 6% = 1% real rate.

(Q5) Apart from Interest Rate & Inflation, what else can affect gold price?

(a) Hedge to volatile equity markets - Typically when equity markets are volatile, investments shift from Equity to Gold temporarily for stability

(b) $ - Gold is traded in $. When $ increases, gold becomes expensive & hence demand is expected to fall & hence the price comes down & vice versa.

(Q6) In 2021, Gold in $ terms was down 4.3% but in rupee terms was down 2.6%, why?

- Assuming 1 ounce of gold is $1, lets see the below examples,

(a) When $1 is 70 rupees, the landing price of Gold in India is 70

(b) But when $1 is 75 rupees, the landing price of Gold in India is 75

So when 1 ounce is 1$ and 1$ is 70, your landed cost of gold is 70. Assuming gold does not move in $ terms and is still 1 ounce for 1$ but if rupee depreciated from 70 to 75, in rupee terms, gold has appreciated by 5/70 = 7% in rupee terms. Rupee depreciation works well for Gold prices domestically.

(Q7) What’s happening to Gold right now?

(a) Working in favor of Gold

    - High inflation

    - Negative real rates

     - Volatility in Equity markets

    - Central banks globally are adding to their gold reserves 

(b) Not working for Gold

- $ Strengthening

-Rates expected to go up

(Q8) Wouldn’t rising rates bring Gold down? It almost hit $1850 (Jan 25), why?

(a) Rates are expected to go up but ‘may be’ the market believes, inflation won’t come down so easily (negative real rates will persist). Crude at $90 is a huge inflation concern & hence the rally in Gold from mid December

(b) Very lately, the DXY (Dollar Index) broke over 97 & we saw gold give away some gains.

Not sure which side will win but for gold rally to continue, DXY needs to fall first below 97 & lower there after.

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hemantpagi

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