Why are Gold Prices falling?

Gold prices have slipped to a new low this year at $1,072.35 and recovered to trade above $1,115 an ounce mark at the time of writing. In rupee terms prices have slipped closer to the Rs. 25,000 per 10 grams mark. Some heavy bout of selling at a time of low liquidity (also with Japanese markets closed today) seems to have been behind the sharp fall in gold today. From a fundamental perspective, with the expectations of Fed rate hike materializing in September to have advanced, which in turn leant strength to the US dollar and pressurized gold. We did expect some selling as we near the rate hike. Also, with the Greece saga behind us at least for the time being, it would have removed an added layer of demand.

On the other hand, we also had China announcing an increase in its gold reserves after six years. China last reported a figure of 1,054 tonnes in April 2009, and now says it sits at 1,658 tonnes of Gold reserves today – an increase of 57%. The central bank’s gold holdings make it the fifth biggest gold reserve in the world, surpassing Russia. The issue here is - contrary to expectations China has bought just too little. There were expectations that China is looking to diversify away from the dollar and surely a pie of it would come to gold. Although China has made a significant increase in its gold reserves, it is still only a small portion of its total foreign reserves. Gold now accounts for 1.65 percent of China`s total forex reserves, against 1.8 percent in June 2009. Some are also worried that despite the buying of about 604 tonnes, gold prices are still falling.

The only matter of fact remains that China’s tonnage has increased by 604 tonnes since April 2009. The buying could have taken anytime during the period. One can only speculate on the timing of the purchase. Gold price peaked in mid 2011 and it could be that all the 604 tonnes have been purchased before 2011 as uncertainty was high at that time. Or China may have purchased at regular intervals and averaged their price or may be China has bought recently to take advantage of the fall in price. It’s just anybody’s guess about when China would have bought but importantly it’s more likely that China may add more to gold its reserves given its need for diversification. This could be an opportune time to add more gold, for China, when prices are low.

Gold markets will continue to remain fixated on interest rate hike in the U.S. not to rule out the probability of any further correction, prices should find some support from the cost of production dynamics and the ongoing theme of diversification of investments and reserves.

As we approach the rate increases in the U.S, it could be accompanied with further speculative selling on the prospects of further hikes and all talks of real rates moving higher. After the initial rate normalization jitters, the environment will likely be far more positive for gold. It is thereafter markets would shift focus from timing the rate hike to the likely nature and extent of rate hikes. The Fed may not want to run risk of a too divergent monetary policy then its global counterparts as that would lead to a significant further appreciation in the dollar. Even the current dollar strength seems to be hurting the US economy rather than halping. Also, the Fed has been openly saying that the Fed rate hike would be gradual, so it’s no point shooting in the dark and expecting an aggressive tightening cycle. We reiterate our view that as the market figures out that Fed will stay behind the curve and do only little and keep real rates negative for much longer, gold should start moving northwards.

We also reiterate that the main reason to own gold is just the sheer fact that it is one of the good portfolio diversification tool and thereby helping you to reduce overall portfolio risk. The fall in prices provides an opportunity to build your intended allocation to gold.

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Above article is authored by Quantum.

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