Amid Inflation, Geopolitical Risks, Is Gold Set For A Bull Run?

Inflation, geopolitical risk and a rethink on central bank reserves. Could these factors drive gold prices higher?

<div class="paragraphs"><p>Cow figures made of gold. (Photographer: SeongJoon Cho/Bloomberg)</p></div>
Cow figures made of gold. (Photographer: SeongJoon Cho/Bloomberg)

Gold is considered a hedge against inflation. Negative real interest rates can buoy demand for it. The yellow metal is also seen as a safe haven in times of geopolitical stress. And central banks see the benefits of it when fiat currencies in their reserves are volatile.

What happens when all these factors come together, as they are currently? Is gold set for an upmove globally and in India?

Gold prices traded at over $2,050 per ounce on Wednesday, a rise of nearly 19.5% over a year ago, according to Bloomberg. Over the past 10 days, as Russia invaded Ukraine, gold prices have risen more than 7.7%.

In Indian rupee terms, gold has risen to Rs 53,192 for 10 grams on Tuesday, 12.6% higher than a year ago, according to data from the Multi Commodity Exchange of India.

A research note dated Feb. 28, 2022 by JPMorgan forecasts an average price of $1,808 per ounce for gold in 2022.

Bank of Baroda expects gold prices to breach the $2,000 mark in the next 4-5 months, spurred by a volatile geopolitical situation. While prices may correct if tensions abate, gold is likely to trend in the range of $1,750-1,800, said Dipanwita Mazumdar, economist at Bank of Baroda.

The Russia-Ukraine crisis resulted in a sharp selloff in risk assets like equities and cryptocurrencies as investors rushed into gold, the U.S. dollar and U.S. Treasury bonds, said Chirag Mehta, senior fund manager for alternative investments at Quantum Mutual Fund, in a note.

Mehta explained that there are conflicting factors that may impact gold prices. "A stagflationary environment will be supportive of gold prices but will eventually clash with the U.S. Federal Reserve's tightening cycle, which is expected to keep gold prices in check." However, if there is a U-turn on expected rate hikes due to geopolitical risks, it would be a "big win" for gold, said Mehta in a note dated March 4.

Stronger Central Bank Demand?

Another factor that could boost interest in gold is the decision by developed nations to freeze a part of the reserves held by the Russian central bank in dollars. The decision could force yet another rethink on diversification of central bank reserves.

The sanctions to Russia are a bid to show supremacy and power and countries are realising that they don't want to be at the mercy of other countries. "As such, there is a rethink on foreign reserves and the need to incrementally diversify them," Mehta told BloombergQuint.

According to data from the World Gold Council:

  • Central banks added 463 tonnes to global gold reserves in 2021, 82% higher than 2020.

  • This pushed global gold reserves to just under 35,600 tonnes, their highest for almost 30 years.

The Reserve Bank of India, too, has seen a rise in its gold holdings. The RBI's holdings of gold are close to 7% of total reserves, lower than a decade ago because of a sharp rise in foreign currency assets in recent years.

Central banks stock gold for safety, liquidity and then returns, said Somasundaram PR, managing director at the World Gold Council. "The dollar is not so much the currency of choice, as it is the currency of convenience. Once the current geopolitical crisis subsides, we have to see what the implication is for the next preferred asset class—gold."

Local Demand: Consumption Vs Investment

Locally, a different set of factors may play out.

According to Somasundaram, price-sensitive Indian buyers tend to sit out periods of high prices and buy when the cost of gold falls. For instance, there was a sharp rise in demand for gold when prices dropped in March last year. A similar scenario may play out if prices rise now.

An earlier study by the World Gold Council had found that income is the biggest driver of gold demand in India.

India is the second-largest consumer of gold, but per capita consumption is low. India's gold consumption is at about 0.5 grams per capita, while China's is at about 0.6 grams per capita.

Other factors such as a negative real rate of return on deposits are not driving factors for gold demand in India, Somasundaram said. "Demand for gold is still determined by social occasions, festive and wedding season, auspicious days and the monsoons," he said. "The linkage with interest rates is limited because these are long-term buyers."