Gold monthly view for October 2021

After ending last month in the mid $1,700 levels, international gold prices hovered near $1,800 in October as investors worried about inflation.

Even while central banks maintain that the spike in inflation is short-lived, the phenomenal breakdown in supply chains, high energy prices, and accelerating wage growth suggest higher for longer inflation and have complicated the global recovery. Consumer Price Inflation in the US continues to be at 3-decade highs. Experts have pointed out that oil prices, which have touched multi-year highs of $85 per barrel, are likely to remain structurally higher going forward as global oil consumption rebounds amid tight supply after years of underinvestment in the sector and growing pressure to transition to green energy. And even if the increase in prices of goods and commodities turns out to be “transitory”, it is resulting in workers demanding higher wages to get back to their jobs as the pandemic recedes. This increase in wages cannot be reversed, tends to create a vicious cycle and thereby results in sticky inflation.

On the other hand, the world's recovery faces a critical moment with central banks starting to unwind stimulus just as the global economy is slowing thanks to raw material and energy shortages, labour market losing momentum and consumer sentiment souring due to rising prices. The US economy created only 1,94,000 jobs in September compared to estimates of 5,00,000. In its latest World Economic Outlook, the IMF has downgraded its outlook for the global recovery this year to 5.9% from its projection of 6% in July.

With the risk of stagflation growing, gold has begun to find support.

Global debt is fast approaching $300 trillion and that complicates the normalization of monetary policy. With interest rates at ultra-low levels, servicing this ballooning debt hasn't been very difficult. However, if central banks hike them, the interest costs will increase, putting pressure on governments and businesses. On the flip side, if rates are not hiked in time, inflation could get out of hand only to result in aggressive tightening later which could trigger debt crises and stock market eruptions. Gold can benefit from the resulting risk aversion.

Fed Chairman Jerome Powell recently commented that though he thinks it’s time to taper, he doesn't think it’s time to raise rates. While unwinding of monetary stimulus by the Fed as soon as in November will support the dollar and hurt gold, investors are expecting the Fed and other major central banks to lag behind inflation, which will mean negative real yields will remain well into next year and gold with its inflation-combating abilities will reassert itself.

While optimism about economic recovery has kept domestic risk assets popular and gold struggling, there are concerns about the sustainability of market valuations. There are macroeconomic risks that can increase stock market volatility in the coming months. Festive celebrations amid lower vaccination rates can increase the chances of a third wave in India. Monetary tightening in the developed world could impact flows to domestic markets and higher input cost inflation can negatively impact corporate earnings. Holding negatively correlated gold in the portfolio can help investors tackle any equity market corrections.

Economies of major gold consumers India and China have bounced back from the pandemic induced recession. India imported 91 tonnes of gold in September, compared to 12 tonnes a year earlier. Consumer incomes and sentiment have improved. A recent report by the World Gold Council reveals that for each 1% increase in gross national income per capita, domestic gold demand in India has historically risen by 0.9%. Pent up demand thanks to lockdowns and postponed marriages is now supporting prices. A good monsoon and the upcoming festive season in India should further aid the uptick in consumer demand. This is a classic two-hand approach that works well for gold markets where the increase in physical demand supports prices providing a floor in times of slower investment demand. Gold prices have fallen substantially over the last year. As per the World Gold Council, for each 1% fall in gold prices in a year, Indian demand for gold increases by 1.2%.

Firming crude oil prices and the surge in imports with domestic demand bouncing back is set to increase India's trade deficit and pressure the rupee. The strengthening of the dollar is further weighing on the currency. A depreciating rupee should keep domestic gold prices well supported.

Given the current macroeconomic background, investors should maintain their 10-15% allocation to gold. Those with lower allocation can take advantage of such phases of consolidation in prices to build their exposure.

Sources: Bloomberg, World Gold Council

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