Gold has lost its mojo over the last three years, losing about half its value since 2012. But action in the yellow metal is set to return. Trouble is brewing for gold bears. The metal is already up by about 2 per cent from its six-year low of $1,046/ounce recorded in early-December.
On Thursday, after the news of the Fed rate hike, gold dropped just 0.3 per cent.
Gold may not deliver double-digit returns, but surely 2016 will be a better year than 2015.
The US Federal Reserve on Thursday increased the short-term rate by 25 basis points, taking it up from a near-zero level since 2009. However, it has given clear indications that the pace of increase in rates from hereon will be gradual. Expectations are that rates may touch 1-1.5 per cent by end-2016 and 2.4 per cent by 2017.
This is good news for gold.
Diving into the data for the last 20 years, one sees that during an uptrend in US rates, gold moves up and dollar declines. In 2004, 1999 and 1994, gold prices gained 5-10 per cent in the six months after the first/second rate hikes.
For instance, in the year 2004, between June and December, short-term rates in the US went up to 2.25 per cent from 1.25 per cent. During this period, gold moved up 11 per cent and the US dollar index that measures the value of the greenback against six major currencies, plunged 9 per cent. In 1999, between June and November as rates rose to 5.68 per cent from 4 per cent, gold delivered an 11 per cent return and the US dollar slipped 0.8 per cent. Similarly, in 1994, when Fed lifted rates to 6 per cent from 3.5 per cent, gold prices rallied and dollar dropped.
Fundamentally too, gold prices appear to have bottomed out.
Most gold miners are seeing their cost of production hover at about $1,000/ounce now. If gold prices fall further, their operations may turn unviable and they may be forced to shut shop. This will hit the global supply of the metal.
Some risks There are some risks to the bullish stance on gold. With oil prices continuing to fall on the back of rising inventories of US crude and the high possibility of an oil glut in 2016, there is no assurance that inflation in the US will get to the Fed target of 2 per cent any time soon. This may see demand for gold as an inflation hedge, drop. Also, dollar may hold its fort and not leave any profits for gold investors. The paper gold market is already in a surplus. If outflows continue, it may also have a negative bearing on the yellow metal.
Watch the rupee For Indian investors in gold, the rupee will be a key deciding factor. The bullion contracts in the futures market as well as the gold ETFs are denominated in rupees. If the rupee weakens against the dollar, it will augur well for domestic investors. But if the currency strengthens, it will eat into gains made on the appreciation in the price of the metal in the international market. Consumers, who have been postponing their purchases waiting for gold to fall further, may not see any significant price corrections from here.