Gold outlook Diwali 2021: US Fed meet, inflation, post-festive demand; golden or gloomy days in Samvat 2078?

fundamental factors such as the hawkish Fed's tone on brighter US economic outlook and rising inflation could cap the upside for the gold prices

By Amit Pabari

Diwali is one of the biggest Hindu festivals, celebrated not just in India but in many other countries too. During this festival, one of the auspicious things is to wear gold or buy (invest) in the gold. Gold is a positively-charged metal that promotes optimal oxygen distribution to the cells in your body. And that’s the reason many Indians wear gold jewellery during festival days. Apart from an investment or buying gold on an auspicious day (Dhanteras), people also trade (frequently buy and sell) to make money out of it. Some traders look at it from an industrial point of view also as it is used in the manufacturing of electronics. One can go and buy for a ‘Shagun’ purpose on any auspicious day, but the outlook on the same remains uncertain and gloomy. Why are we suggesting to avoid it for trading or investing? Let’s go through key fundamental factors one-by-one and check the outlook.

Hawkish Fed could cap upside in Gold

Apart from its own demand and supply, what matters most to the gold price is the central bank’s policy; especially Fed’s policy stance. Last time, when the Fed had tapered down its Quantitative Easing in 2013, the gold prices had ended their 12-year bull run and fell by almost 30% to trade at $1200 an ounce. However, in rupee terms, gold posted a marginal 3% decline due to a massive 12% depreciation in the currency against the dollar. The biggest reason behind the fall is the optimistic outlook on the US economy, policy tightening from the Fed, sluggish EM outlook, and stronger US dollar. This led to a spike in the real rates, which usually have a negative correlation with gold. The situation is not so different from the 2013 taper period.

The Fed is on course to taper down its QE once again in the November policy meeting. The yields are discounting the rate hikes too. The only concern or differentiating point compared to 2013 is real rates. Due to escalating inflation expectations, real rates are not able to come into the positive territory, and hence gold is still supported. Once inflation expectation starts settling down at some point in the future, and if we have a jumping nominal yield on optimistic US growth, then real rates will start recovering. And thus that could lead to a fall in safe-haven demand. The reason behind this is the higher interest rates which means higher opportunity costs of holding non-interest-bearing assets, such as precious metals, making them relatively less attractive. Thus, traders, investors, or hedgers could target further lower levels in the international gold prices.

Stronger India’s demand due to festive season, but gloomy outlook ahead

India’s gold demand has seen a 47% year-on-year jump in the July-September quarter to 139.1 tonnes, following strong economic activity and recovering consumer demand, the World Gold Council said in a report. However, India is facing a record level deficit due to higher imports of oil. Thus, the demand could dry out once India finishes its Diwali celebration. Moreover, the growth outlook on other EMs are still sluggish and hence demand in the upcoming months likely to remain murky.

Gold- No inflation hedge anymore

There was a time when gold was considered an inflation hedge. Despite soaring inflation across the globe due to rising demand and supply bottlenecks, the gold prices are hovering near $1780 per ounce levels. If it was a perfect inflation hedging instrument, then ideally prices would have jumped over the recent months. But changing business and investment dynamics over the recent years have changed this theory. Rather than investing in gold during rising inflation or keeping gold into a portfolio mix, now traders and investors have started looking at other alternatives like cryptocurrencies.

Outperforming equities are attracting the flows

Post COVID-19 lockdown, all central banks had started flooding the financial market with ample liquidity. Along with that higher vaccination drive helped the business activity to restart it and at the same time demand also rose sharply. This led flow to start chasing riskier assets like equities. And that story is still on. In the case of India, equities are up by more than 25% for the year, although diverging with other EM. Further, US markets are also near record high due to beating corporate estimates. This has clearly slashed investments in gold up to some extent, at least on a comparable basis.

Technical setup: As clearly observed in the below weekly chart of international gold, prices were in a bearish mode in 2013-14 when the Fed was on a course of reducing their asset purchase. The replica chart can be seen in 2021 and further could also be extended in 2022. On the resistance side, the prices could face a roof near $1835 and further at $1880 levels. Whereas, support lies at $1720 and $1675 levels. The bias remains on a downside and if $1675 is taken out then we could see prices correcting down to $1625-1610 levels over the medium term with a 4 to 6 months perspective.

Outlook: In nutshell, fundamental factors such as the hawkish Fed’s tone on brighter US economic outlook and rising inflation could cap the upside for the gold prices. Further, gloomy Asian demand post-festive season and diverting flows towards riskier assets could be reasons for the gold’s underperformance.

International Gold Levels: Hence, it is advisable for the traders to sell on every uptick close to $1835 levels for a lower target of $1720 and $1675 levels. For international investors, it is advisable to wait for a deep correction in gold prices.

Domestic Gold levels: For domestic investors, it is advisable that prices could move in a sideways zone as the USDINR pair, one of the derivative components of local gold prices, is likely to move steadily higher towards 75.50-76.00 levels over medium term. If international levels slides drastically, then we could see a correction upto 46000-45500 zone. On the upper side, resistance is located near 48450 and further at 49300 levels, which seems unlikely to break over medium term.

(Amit Pabari is managing director at CR Forex Advisors. Views expressed are the author’s own.)