On last Wednesday gold registered one of its biggest ever fall since December 2011 and lost nearly 5% in a single session of trade. No explicit signal from the US Fed Chairman Ben Bernanke about further monetary easing impacted gold prices. So, will a structural change in monetary policy bring an end to the bull run in gold? Well, before moving on to that question let us first understand how monetary policy is linked to gold prices. And then we will ascertain whether or not a shift in monetary stance can really change the course of gold prices.
We know that low interest rates are a disincentive for investment in other asset classes like bonds and currencies. But loose monetary policy (low interest rates) also creates a favorable borrowing climate which is intended to boost the capex cycle and revive the economy. Thus, stocks appear to be a good investment avenue during such times. However, when there is a confidence crisis and business sentiments are low even near zero rates fail to revive the capex cycle. Thus, equities too appear to be risky bets then. Being a safe haven, only gold thrives during such times justifying the cor-relation between low interest rates and high gold prices.
So, has Mr Ben Bernanke's silence over further monetary easing effectively meant an end to the bull run in gold? Not really, if we dig deep into the relation between interest rates and gold prices.
We now know that there is an inverse cor-relation between interest rates and gold prices. And since the nominal interest rates in the US and UK are near zero real interest rates are effectively in the negative territory. For instance, real interest rate in US is -2.75% while the G7 average is -1.8%. Hence, unless the real interest rate turns positive by a substantial amount gold prices will continue to remain firm. Because only when they turn positive there will be some benefit from holding paper assets. Again, gold being a safe haven and the economic scenario in the Western world being weak, demand is expected to remain buoyant. Thus, unless a concrete monetary tightening cycle begins or the risk appetite of investors increases suddenly gold prices are expected to remain firm.