Gold prices already factoring in US Fed rate hike: World Gold Council

Washington (July 23)  At around $1,100 an ounce (oz), gold prices are near their five-year lows. The fall over the past few sessions has been triggered by comments by US Fed Chair, Janet Yellen indicating a possible hike in interest rates in 2015 given satisfactory growth in the US economy.

Also impacting sentiment was a sell-off in China where that saw five tonnes of gold being sold through the Shanghai gold exchange.

In a recent report titled 'Investment Commentary: Looking into H2 2015', World Gold Council (WGC) suggests that though investors were puzzled that the prices of the yellow metal did not increase in the first half of 2015 (H1 2015), gold price movement was consistent with market expectations that the risks could be contained.

The report suggests that investors expected gold to have reacted much more to Greece missing its June payments to the IMF (International Monetary Fund) and the possibility 'Grexit', the necessary restructuring of Puerto Rican debt, or the pullback in the Chinese stock market.

Though gold can be an effective tail-risk hedge, WGC says, its price reacts more when the risk is systemic - that is, when a market event spills over to other sectors and regions. However, when the event is localised (to a region or sector) the gold price usually does not react as much.

"In our opinion, the movements in the gold price earlier this year reflected market expectations that the events in Greece or the pullback in Chinese stocks were local - not global - risks and that the possibility of a disorderly outcome was/is still low. This does not necessarily mean that the market is correct. It simply reflects its current view," the report says.

As an example, it cites the 2008-2009 financial crisis, when the gold price trended lower until Q4 2008 - post the Lehman default. Once the ramifications of the crisis became clear to all, the market consensus shifted, equity market losses accelerated and the gold price went up.

"Should the conditions change and the risk of contagion or the unintended consequences of a Greek exit increase, we would expect to see a stronger reaction from the gold price. As a high quality, liquid asset, it is likely that many investors would use gold to protect wealth. Similarly, the recent Chinese stock market sell-off hasn't resulted in a large uptick in the gold price thus far. A more substantial market correction in China, however, could spill over to other economies, increase uncertainty worldwide and make gold a more relevant hedge," it adds.

WGC believes that the gold prices are already factoring a rate hike by the US Fed.

"Investors now seem focused on the direction of the US dollar and the Fed's monetary policy stance. We believe that the gold price already reflects a possible rate hike later this year and that the US-centred perspective is missing a more comprehensive view of the market," WGC says.

"Whether it happens over before the end of the year, or later, we believe that the gold price should already incorporate, at least in good part, current market expectations of a rate hike. In our view, the gold price may be less susceptible to the first rate hike when it actually occurs and the main focus will be the pace at which the Fed signals it will continue raising rates," it adds.

Source: Business-Standard