Gold prices are correcting from its recent peak, and there are a lot of noises in the market suggesting that gold would soon start its correction, which is a direct challenge to the prevailing belief in theories that gold demand surges at the time of uncertainty.
The prevailing scenario across the global front is somewhat mimicking the financial crisis of 2008 and the Lehman Brothers crisis in terms of sentiment.
The market uncertainty or pessimism push gold prices up, then why gold prices are going down at the present time when uncertainty is at peak and market is as volatile as it was during 2008.
The possible reason for the same could be margin calls on investments due to the brief plunge. When an asset rises, it is typically followed by a large influx of money with buy and hold strategy to ultimately beat any volatility and gain the best of the rally of the underlying asset.
However, at the time of a fall, maintaining a long position in the underlying asset could be challenging in terms of money and psychology both. In general, the panic factor usually dominates the greed factor, which as explained and fostered by the renowned trader and writer- Alexander Elder, is the main reason, an investor cannot easily book loss or square-off a position in red.
The same logic works at the time of a brief plunge, which surprises market participants suddenly. A nominal investor or trader is more inclined to keep their loss position intact in the hope of market recovery, which in turn, prompts them to pull money out of recently exposed asset to prevent loss booking of falling investment.
In a general scenario, when equity assets nose dives, gold is expected to surge slightly, which makes it an attractive investment for investors looking to hedge and also play on the short-term price volatility of equity market by allowing to toggle money between gold and other assets.
However, as the major investment of retail investors, which is usually equity, falls, it drags their money out of other assets to enable them to ignore booking losses, which in turn, keeps a short-term lid on assets, which performs well during market uncertainty such as gold.
To Know More, Do Read: Margin Calls Across Risky Assets Putting Gold Under Pressure
The Antecedence of Gold Rally
- Financial Crisis 2008
The infamous financial crisis of 2008 started with the depreciation in the subprime mortgage market across the United States in early 2007 to later become a developed full-blown international banking crisis post the Lehman Brothers filed for bankruptcy.
In 2007, gold prices surged from USD 641.50 per ounce (low in August 2007) to peak at USD 1,031.20 per ounce (high in March 2008); however, before the subprime mortgage crisis could develop into a global banking crisis, the gold retracted in the market and fell to reach USD 738.00 per ounce in September 2008, the month when Lehman crisis took place.
The fall in gold at the time of uncertainty was evident, which was opposite to the theory; however, the fall was on the weaker foot and lack of fundamental, perhaps profit booking to cover margin calls.
Gold Spot, 2007-2011 (Monthly) (Source: Thomson Reuters)
Soon after the correction, the gold shot up to the level of USD 1,911.96 per ounce (high in August 2011).
Another theory, which backs this kind of move in gold is that the bullion market precedes the change in economic conditions, and soon problems become evident gold takes it to move. However, after a time, when gold prices reach a peak, the demand for physical gold takes a toll. However, as the situation worsens, the institutional investment flows in gold to safeguard large portfolios to push the price up further.
To Know How Gold Is Poised Now, Do Read: Get Ready to Pay ~2.8k for 24k Gold; Gold Bulls Break the Gated Cage
In the status quo, gold seems to be entering in the correction phase as global economic conditions start weakening, and if history repeats, we might see a fresh rally in gold over the medium-term.
What Would Back Gold Ahead In the Domestic Market
While the demand for gold is dominating the demand and supply balance, another asset, which is currently being sought after by the market is the United States dollar. Most of the consumption-based commodities are denominated in the dollar, which makes it one of the most liquid and highly sought after currency.
The U.S. dollar is showing a decent rally and is also expected by many industry participants to surge further in the wake of the lower interest rate environment. The dollar index, which tracks the dollar against other currencies, is on a continuous surge from 88.25 (low in February 2018) to the present high of 102.99 (intraday high on 19 March 2020).
The hoard for the dollar is further capable of depreciating cross currencies such as AUD, which in turn, would support the spot gold denominated in AUD further.
To Know More, Do Read: Low GDP Growth, Coronavirus Pandemic – Push AUD to Decade Lows; What’s Next?
DIIS Gold-Related Forecast
The Department of Industry, Innovation and Science (or DIIS) anticipates the gold price to average USD 1,475 an ounce in 2020, up by 3.7 per cent against the previous year amid higher investor demand for gold as a safe-haven asset.
DIIS also suggests that the low interest rate environment is likely to drive institutional investment demand for gold.
To Know More, Do Read: ASX-Listed Gold Stocks- An Emerging Ray of Hope for Domestic Investors
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