Is The Gold Price Gain On Fed Inaction Sustainable?

Gold prices jumped to a two-week high on Friday after the US central bank left the key rates unchanged. As gold reached $1,142 per ounce last week, it also snapped a three-week losing streak. Gold had been trading higher right ahead of the outcome of the FOMC meeting last Thursday as many traders had predicted no rate hike. A rate hike decision would have made it difficult for the non-yielding commodity to attract investors away from Treasury bonds. Higher rates would have also led to a surge in the dollar, making dollar-denominated gold more costly.

However, it is not certain yet if the rally would continue and help gold funds. Major growth countries, particularly China, have been suffering dismal economic conditions. The outlook in general is also bearish. This may hurt gold as demand in these regions remains the key indicator of buying trends.

Gold & Interest Rates

Gold has a negative correlation or inverse relationship with interest rates. Opportunity costs of holding gold increases amid higher interest rates. Gold is viewed often as capital preservation asset and a currency that has no yield. So if there are higher yields elsewhere, the cost of holding gold goes up. The yellow metal offers no yield and thus the price declines. A surging dollar, a result of higher rates, also has an inverse relationship with gold prices.

Gold moves higher amid ultra-loose policy and is also employed as a hedging strategy during inflation. A low rate environment pushes demand higher for gold, as quantitative easing measures subdue inflation.

Rate Hike Delaying the Inevitable?

After concluding the two-day policy meeting, the Fed decided last week to keep the short-term interest rate unchanged at a near zero level. Sluggish global economic growth, an increase in volatility in financial markets and a low inflation level held the Fed back from hiking rates. Nine out of 10 policy makers voted in favor of keeping the rate at the near zero level.

However, out of 17 committee members, 13 indicated that a rate hike may be possible this year. On that note, it will be difficult for gold to sustain the rally. A hike in December is possible, and that would turn the tide again for the yellow metal, which nevertheless is under extreme pressure. In fact, Bloomberg generic pricing showed gold for immediate delivery had dropped 0.3% at 11:16 a.m. in Singapore after indications from some policy makers that rate hike may come this year. The Federal Open Market Committee will meet on Oct 27-28 and again on Dec 15-16.

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