Could find support from differentiated approach towards risk

G. Chandrashekhar

Retaining lustre

Surge in

gold rates driven by a variety of factors

Amount of

gold deposited n trustee accounts has risen

Not much

sell-off at gold exchange traded funds

Mumbai, July 5

After the FOMC meeting in June-end, when interest rates were raised, gold has staged an attractive recovery with prices reaching upwards of $620 an ounce early this week. Gold's positive reaction to a rise in interest rates is not the rule.

This time round, the surge in gold prices was driven by a variety of factors. According to experts, in the inflation versus growth dilemma, the Fed favoured the latter.

De-risking investments

Commodity prices started to fall in May after investors got increasingly concerned over global economic growth, and de-risked their investments, i.e., withdrew funds from a variety of risky asset classes following a broad-brush adjustment of risk premiums. Gold suffered along, notwithstanding its known fundamentals and value as a safe haven investment and hedge against inflation.

The Fed statement removed some uncertainty as it specifically stated that the central bank would not only look after inflation but also take account of the US economic health, according to Macquarie Research Commodities. A more differentiated approach towards risk means that gold is set to find additional support.

Other asset classes

Meanwhile, other asset classes should under-perform.

For instance, a decline in growth rates and inflationary pressures (as indicated in the Fed statement) are not a good combination for equities, which are, therefore, expected to perform less well going forward. "This removes one of gold's competitors for funds," Macquarie said.

The market is wondering whether the peak of the tightening cycle is close. Of course, there are differences of opinion, with some experts expecting further hikes in the coming months, going up to six per cent, while others do not believe the rate would go beyond 5.5 per cent.

It only means that the interest rates differential is losing its shine and the downward pressure on the dollar is set to persist. No wonder, another factor to help gold is the weakness in the dollar after the Fed meeting.

No much sell-off

Paradoxically, looking at various gold exchange traded funds, there was not much of a sell-off in May and June despite a sharp decline in market (prices dipped as low as $543 an ounce).

Indeed, after the market bottomed out, the amount of gold deposited in trustee accounts has actually risen.

As of July 3, it stood at a new record high of 511.7 tonnes.

It is evidence that, by far, not all of the interest in gold is of a speculative nature.

After the recent market correction, the biggest risk to positive outlook for gold could be a resurgence of risk adversity, leading to a broad-brush pulling out of funds across various markets and asset classes. Will that happen?

"One possible starting point for this may, for instance, be a further step-up in inflation-busting rhetoric from the Federal Reserve," said Macquarie.

(This article was published in the Business Line print edition dated July 6, 2006)
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