A rate cut by the US Federal Reserve and fears of an escalation of conflicts in the Middle East bolstered the appeal of the yellow metal, sending the benchmark London spot prices to a fresh lifetime high of $2599.92 an ounce last week. The Fed slashed its interest rates by a surprise 50 basis points on September 18 following a two-day meeting.
The Federal Open Market Committee lowered the federal funds rate to a range of 4.75% to 5%, for the first time in four years and hinted that more cuts are likely before the end of the year. The Fed also noted that its goal is to keep inflation under control without hindering the job market.
There were expectations that a steeper cut could lift bullion prices considerably, but it ended up with moderate gains. This was due to a steady dollar which gained ground after the Fed rate cut. Gold has been on a bullish trajectory in the past many months on rate cut speculation. Slashing rates generally tends to lift prices higher due to lower opportunity cost, a weaker dollar, inflation concerns and increased investment demand.
When there is a decline in interest rates, the opportunity cost of holding non-interest yielding assets decreases. Lower rates make bonds and savings accounts less attractive to investors. This raises the demand for bullion, leading to a rise in its price.
Rate cuts are usually implemented to stimulate the economy, but it occasionally leads to inflation. Gold is traditionally viewed as a hedge against inflation, so if investors anticipate a rise in inflation due to lower interest rates, they may consider investing in gold. However, the relationship between gold prices and interest rates is uncertain and unstable because gold prices in the global market are subject to factors far beyond the control of the US Federal Reserve.
Gold prices have also surged due to fears of an escalation of tensions in the Middle East after Hezbollah vows retaliation for a pager attack. After the unprecedented cyberattack, the soaring tensions between Iran-backed Hezbollah and Israel could spiral into a full-blown war.
Gold has a solid history as a crisis hedge as it has no credit risk and negative correlation to risk assets. Hence, investors tend to flock to it in times of uncertainty, instability, and geopolitical crisis.
When geopolitical tensions rise, especially during war, investors become more risk-averse. They fear that conflicts could negatively impact financial markets and economies across the globe. As a result, they seek refuge in safe assets like gold, which are historically perceived as safe investments.
Domestic prices also surged in tandem with the overseas market. In the key futures market, prices convincingly trade above Rs 73,000 per ten grams gaining over 8 percent since 23rd July when the government halved the duty on bullion.
Looking ahead, the outlook for gold remains bullish in the near future. The surprise rate cut suggests the US Fed is taking the threat of a slowdown in the US economy seriously, which could boost the safe-haven demand for the commodity. Likewise, the escalating geopolitical conflicts perhaps attract more investors into the metal due to its inflation hedge appeal.
(The author is Hareesh V, Head of Commodities, Geojit Financial Services.)