Those who track the yellow metal closely know that the price of gold has been rallying for quite some time. In rupee terms, the precious metal entered the bull market in May 2019.

At that time the price was around ₹32,000-33,000 per 10 gm. Last week, it hit ₹67,000 per 10 gm. The price has doubled in a little less than five years, yielding a compounded annual return of a little more than 15%.

The price was around ₹63,000 per 10 gm just last month. So, even the short-term returns have been good.

What’s the reason for this spike in price?

Well, concerns about high, sticky inflation and the global economy falling into a recession is one of the main reasons.

This is because gold is a ‘safe haven’ asset. It does well when there is fear in the market as opposed to stocks that do well when there is optimism in the market.

But as gold has risen, the bulls have become a little nervous. If there is a correction in the gold price, they stand to lose much of their profits accumulated over the years.

So, how could this happen? When will gold prices fall?

Well, there is only one big reason that could cause the gold price to fall.

Interest rates in the US

US interest rates and gold prices (measured in dollars) tend to have a negative corelation. This means they tend to move in opposite directions.

When the benchmark US 10-year bond yield spiked to nearly 5% in October last year, gold fell to US$ 1,820 /oz.

Since then, gold has recovered very well. It has risen close to 20% to about US$ 2,200 /oz. At the same time, the benchmark US 10-year bond yield has stabilised at a lower level of 4.3%.

This was due to a widespread belief in financial markets that the US Fed will cut interest rates this year a few times. Analysts tracking the Fed had even projected four rate cuts in 2024.

These rate cuts would have kept a lid on US interest rates. This, in turn, would have supported higher gold prices.

However, inflation has played spoilsport.

Inflation in the US fell from 9.1% in June 2022 to just 3% in June 2023. This sharp decline is what gave the Fed confidence to state that they could cut rates. The market certainly believed it.

However, since then, US inflation has remained stubbornly at around 3%. In fact, in February, inflation rate in the US unexpectedly edged up to 3.2% compared to 3.1% in January.

The market is worried that the Fed may push back or ever cancel its plans for cutting interest rates. In fact, if inflation were to rise further, the Fed might consider its fight against inflation incomplete and decide to raise interest rates even more.

Such an event would send the benchmark US 10-year bond yield soaring higher. This, in turn would put serious pressure on the price of gold.

If investors can get a higher yield from a safe asset like US government bonds, then their allocation towards all other assets, including gold will decline.

This would push the gold price down.

Now, gold investors in India will have to consider the dollar-rupee rate as well.

If the rupee declines, then the gold price will receive support and vice versa. This will act in unison with the international price of gold.

Conclusion

At Equitymaster, we recommend holding at least 5-10% of one’s total investments in gold. It makes sense to hold some gold in one’s long-term portfolio, but it doesn’t make sense to speculate on short term price movements.

Also, while considering an investment in gold look beyond 2024. Just because the price of gold is going up this year, doesn’t automatically make gold a great investment.

Disclaimer: This article is for information purposes only. It is not a stock recommendation and should not be treated as such.