Gold gains reverse after US credit rating downgrade

Gold prices reversed some of its gains on Thursday after Fitch Ratings downgraded the US credit rating, which weighed on the US dollar, and had boosted the safe-haven asset.

At the time of writing, gold (GC=F) was trading down 0.26% at $1,969.80 an ounce. Since the start of the year it has gained about 8% but has not returned to the $2,081.58 peak seen on 3 May — close to the high last seen in March the previous year, just after Russia’s invasion of Ukraine.

Laith Khalaf, head of investment analysis at AJ Bell, told Yahoo Finance UK: “Gold has been trading at around $1,950 an ounce for most of this year. The precious metal is often seen as a safe haven, but investors also need to be careful not to equate this with price stability.

“People do tend to flock to the precious metal in terms of financial stress, but it shouldn’t be taken as read that gold isn’t volatile. It is, and steep losses can be incurred. Between 1980 and 1982, the gold price fell by over 60%, and between 2011 and 2015, it fell by around 45%.”

Gold has been a top performing asset in 2023, contributing positive returns to investor portfolios, the World Gold Council said in its mid-year outlook.

However, the most recent data on gold’s rate of return to investors, published in January by Statista, showed the annual average return of gold in 2022 was just 0.4%. In 2021, it said the return of gold was around -3.6%.

What influences gold prices?

Gold is often considered a “safe haven” for being a reliable hedge against inflation and for when the economy is unstable. Gold usually retains its value regardless of economic conditions.

Therefore, the Fitch Ratings US downgrade supported the price of gold this week because it dented confidence in the US economy.

The news also sent the dollar down, which in turn, further boosted the precious metal as it is priced in dollars, providing a lower price opportunity for investors purchasing it in other currencies.

Interest rates are also known to impact the price of gold. While not guaranteed, the price of gold usually decreases when interest rates rise and increases when interest rates go down.

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As it stands, gold’s macroeconomic backdrop is uncertain after the US Federal Reserve raised interest rates by another 25 basis points in July and left the door open for another rise in September.

Analysts at ANZ said this could cap gold’s current price rise.

“We expect shifting expectations around its terminal rate [which] could cap the upside in the near-term. Investment demand remains lacklustre, as investors wait for the Fed to end its tightening cycle."

Meanwhile, Edward Moya, senior market analyst at OANDA, said gold’s rally could extend if growth prospects turn sour.

“If Wall Street starts aggressively in rate cuts by the first quarter of 2024, gold could easily find a home above the $2,000 level.”

Moreover, supply and demand influences gold prices. The higher the price, the lower the quantity demanded — and the lower the price, the higher the quantity supplied.

“I think gold is viewed as a safe haven asset by some investors. So in uncertain times there's probably more demand for it. Given you can't print it — more demand and limited supply can often lead to higher prices,” Simon Popple, managing director of Brookville Capital, said.

Investor behaviour is also a driver of gold prices with many traders adopting a "herd" mentality when there's a price trend.

Gold’s co-relation with the dollar

Gold prices can fluctuate with currency swings, particularly the US dollar as the precious metal is priced in the currency.

For example, when the Fitch downgrade sent the value of the dollar down, gold prices rose as other currencies gain value.

India’s gold appetite

India remains one of the largest gold markets in the world, along with China, according to World Gold Council data.

Therefore, if the demand for gold in one of these countries subsides, it can also impact the price of gold.

In India, demand increased in 2021 by about 78% to approximately 797.3 tonnes. This was a five-year high, according to this gold demand trends report by the World Gold Council.

Simultaneously, gold jewellery demand also doubled year-on-year in 2021, to touch a six-year high of about 610.9 tons.

It was primarily fuelled by urban consumers and tied to weddings and festivals, such as Dhanteras and Dusshera, during which time buying gold is seen as crucial to the social aspect of celebrations.

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Khalaf said that while gold traders often think in just days or weeks, everyday investors usually want an asset they can hold for years, and the long-term case for gold is more nuanced.

"Gold produces no cash flows and has few industrial uses, with demand mostly coming from jewellery manufacture and investment, so it’s more difficult to pin an intrinsic value on the precious metal. Consequently, the long term direction of gold is pretty difficult to gauge because with no cash flows to speak of, sentiment will play a larger part in pricing," he said.

Gold v stocks

Gold peaked in 1980 and fell 33% over the next 20 years, taking 27 years for it to reach its former high.

“That’s a long period in the wilderness. The stock market has of course also experienced some lengthy spells of weak performance," said Khalaf.

"From the height of the dot com bubble in 1999 to the depths of the pandemic in 2020, the FTSE 100 fell by almost 30%. But over this period, an investor would have still experienced a 50% return on their money, with dividends rolled up. There’s no such luck for long-term gold investors who receive no cash payments along the way.”

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However, gold provides diversification in a portfolio because it behaves differently to other assets, especially equities.

“If you’re a conservative investor, you might therefore hold bonds and gold alongside equities because they will tend to perform well at different times. We also now live in a world where cash and bonds are offering much higher yields to investors and that does take some of the limelight away from gold,” Khalaf said.

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