The price of gold (XAU/USD) extends its rally to nearly $4,375 during the early European session on Friday. The rise in the precious metal is supported by growing expectations for further interest rate cuts by the US Federal Reserve and safe haven demand. Traders are awaiting the release of US economic data this month to gauge the path of interest rates. The December US Nonfarm Payrolls (NFP) report will be in the spotlight next week.
The Fed handed down its interest rate by a quarter point at its December policy meeting, bringing the federal funds rate to a target range of 3.50% to 3.75%. Federal Open Market Committee (FOMC) minutes showed that most Fed officials see further rate cuts as appropriate as long as inflation declines over time, although they remained divided on when and how much to cut. Lower interest rates can reduce the opportunity cost of holding gold, supporting the non-yielding precious metal.
Furthermore, geopolitical risks can boost traditional assets such as gold, as they can maintain their value during periods of uncertainty. Last week, Russia accused Ukraine of launching a drone strike on the Russian presidential headquarters in northern Russia, prompting Moscow to reconsider its position in the peace negotiations, according to Reuters. Ukraine rejected Russian statements about the drone attack, and its foreign minister said that Moscow was seeking “false justifications” for more strikes against its neighbor.
However, the yellow metal’s upside may be limited as traders can take profits or rebalance their portfolios. The Chicago Mercantile Exchange (CME), one of the world’s largest commodity trading floors, has raised margin requirements for gold, silver and other metals. These notices require traders to place more cash on their bets in order to insure against the possibility of the trader defaulting upon receipt of the contract.
Frequently asked questions about gold
Gold has played a major role in human history as it has been widely used as a store of value and a medium of exchange. Currently, apart from its luster and use in jewellery, the precious metal is widely viewed as a safe haven asset, meaning it is a good investment during turbulent times. Gold is also widely viewed as a hedge against inflation and currency depreciation because it is not dependent on any specific issuer or government.
Central banks are the largest holders of gold. In their aim to support their currencies in turbulent times, central banks tend to diversify their reserves and purchase gold to improve the perceived strength of the economy and the currency. High gold reserves can be a source of confidence for a country’s solvency. Central banks added 1,136 tons of gold worth about $70 billion to their reserves in 2022, according to data from the World Gold Council. This is the highest annual purchase since records began. Central banks in emerging economies such as China, India and Turkey are rapidly increasing their gold reserves.
Gold has an inverse relationship with the US dollar and US Treasuries, which are major reserve assets and safe havens. When the value of the dollar declines, gold tends to rise, enabling investors and central banks to diversify their assets in turbulent times. Gold is also inversely correlated with risk assets. A rise in the stock market tends to weaken the price of gold, while a sell-off in riskier markets tends to favor the precious metal.
The price can move due to a wide range of factors. Geopolitical instability or fears of a deep recession could cause the price of gold to rise rapidly due to its safe-haven status. As a lower-yielding asset, gold tends to rise as interest rates fall, while a higher cost of money usually negatively impacts the yellow metal. However, most of the moves depend on how the US Dollar (USD) behaves as the asset is priced in Dollars (XAU/USD). A stronger dollar tends to keep the price of gold in check, while a weaker dollar is likely to push gold prices higher.
