Last month's sharp sell-off set gold into a consolidation mode. During the month, gold prices traversed in a broad range of $100 from USD 1,725 to USD 1,625. Considering the significant influence that Dollar movements had on gold prices, gold appears to have regained its negative correlation with the US Dollar. Another rather interesting cause of the large swings noticed in gold markets has been "The Bernanke Factor" - the comments and criticism unleashed by Fed Chairman generating market reactions causing volatility in gold and other asset markets as well.
Since Ben Bernanke's prior public speeches did not hint at another round of Quantitative Easing, there was no expectation of any further monetary stimulus in the near term. As a result, gold prices dipped sharply at the end of last month. However, he recently defended the Central bank's very low interest rate policy and the continuing of its accommodative policies, and also spoke about how the US economy needs to grow more quickly in order to bring down unemployment. This recent statement gave rise to speculations that money-printing exercises would continue, and thus, reinstated investor's preference for gold, causing prices to appreciate.
The volatility in gold prices can be credited to this lack in clarity from policymakers, who despite what they may say, prove in action that they still believe that the economy can only be strengthened through more monetary inflation, further credit expansion and increased government spending.
Other factors such as the developments in the Euro zone and geopolitical concerns, also influence the value of the dollar and in turn that of gold.
Though it may appear that gold is moving along with risk assets, it is actually simply following its historical relationship with the dollar. The immediate economic concerns have been papered over by the policy makers and therefore before we see a fresh bout of crisis, this movement will likely continue until then.
The possibility of a decline in the gold consumption of key countries, viz India and China, could also have an adverse impact on gold markets. The economic growth target announced by China is probably the lowest in seven years and has worked against global growth, curbing prospective demand for commodities including gold. On the other hand, the Indian Government, in a bid to improve its surging current account deficit, has further raised its customs duty by 2%. Duties and taxes now add more than 5% to the gold price. The government has also introduced an excise duty of 1% on non-branded jewelry and a consumer tax of 1% on cash transactions for gold purchases exceeding Rs. 2, 00,000 in value.
While the industry did go on a nationwide strike to oppose these custom hikes, the shutting of shops only further contributed to a decline in demand. Even markets expect that weighing on prices, demand would be impacted, at least in the short term. However, demand from these key consumption centers would likely remain buoyant over the long run baring any short term sentimental impact on demand in the near term.
Outlook: The global economy is shrouded in various uncertainties. The long term issues of rising deficits and debts are still in want of some meaningful resolution. The western world is still grappling with a massive and unrealistic heap of sovereign debt. These high levels of debt, combined with slow economic growth have compelled central banks around the world to 'print' more dollars (and other currencies), stimulate the economy and inflate away the debt burden with an intentional plan of currency devaluation. Countries such as Iran who has stubbornly carried on with its efforts to develop nuclear plants despite all the talks and sanctions impinged on them; have added to the prevailing uncertainties.
In the light of these macro events, gold appears to remain favorable, as an effective portfolio diversifier. Investors should keep allocating to gold in a systematic manner and could use any corrections as an opportunity to buy in.
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