Gold Price: What do the US Federal Reserve rate cut and rising tensions in the Middle East mean for gold prices?

A rate cut by the US Federal Reserve and fears of an escalation of conflicts in the Middle East Rising interest rates have boosted the yellow metal’s appeal, sending benchmark prices on the London spot market to a new all-time high of $2,599.92 an ounce last week. The Federal Reserve cut its interest rates by 50 basis points on September 18 after a two-day meeting.

The Federal Open Market Committee cut the federal funds rate to a range of 4.75% to 5% for the first time in four years and hinted that more cuts are likely before the end of the year. The Fed also said it aims to keep inflation under control without hampering the labor market.

A steeper cut was expected to boost gold prices considerably, but ended with moderate gains. This was due to a stable dollar that gained ground after the Fed rate cut. Gold has been on an upward trajectory in recent months due to speculation about a rate cut. Rate cuts generally tend to push prices higher due to lower opportunity cost, a weaker dollar, inflation concerns and increased investment demand.

When interest rates fall, the opportunity cost of holding non-interest-bearing assets decreases. Lower rates make bonds and savings accounts less attractive to investors. This increases the demand for bullion, leading to an increase in its price.

Rate cuts are usually implemented to stimulate the economy, but occasionally they lead to inflation. Gold is traditionally seen as a hedge against inflation, so if investors anticipate rising inflation due to lower interest rates, they may consider investing in gold. However, the relationship between gold prices and interest rates are uncertain and unstable because gold prices in the global market are subject to factors beyond the control of the US Federal Reserve.

Gold prices have also risen on fears of escalating tensions in the Middle East after Hezbollah vowed retaliation for a pager attack. Following the unprecedented cyber attack, rising tensions between Iran-backed Hezbollah and Israel could escalate into a full-blown war.

Gold has a strong track record as a crisis hedge, as it has no credit risk and a negative correlation with risk assets. As such, investors tend to flock to it in times of uncertainty, instability and geopolitical crisis.

When geopolitical tensions rise, especially during a war, investors become more reluctant to take risks. They fear that conflicts could negatively impact financial markets and economies around the world. As a result, they seek refuge in safe assets such as gold, which are historically perceived as safe investments.

Domestic prices have also increased in line with those in the overseas market. In the futures market, prices are convincingly trading above Rs 73,000 per 10 grams, which is an increase of over 8 per cent since July 23, when the government halved the duty on bullion.

Looking ahead, the outlook for gold remains bullish in the near future. The surprise rate cut suggests that the US Federal Reserve is taking the threat of a slowdown in the US economy seriously, which could boost demand for the commodity as a safe haven. Also, rising geopolitical conflicts may attract more investors to the metal due to its appeal as a hedge against inflation.

(The author is Hareesh V, Director of Commodities, Geojit Financial Services.)