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Thursday, 5 March 2020

Emergency Rate Cut Pushes Gold Prices Higher

After getting caught up in last week’s punishing virus-driven sell-off, gold is seeking to refresh its haven credentials. The metal advanced after a weekend of negative developments, including a surge in virus cases around the world. With rising expectations that central banks will now act, Friday’s big slump in gold was put down to investors’ forced selling to cover losses elsewhere.

Bullion is always considered the safest mode of investment during crisis. Given that, investors tend to sell gold, as prices rise, during extreme turmoil, in order to cover-up losses incurred elsewhere. Similar pattern was seen last week where gold was sold off heavily, a situation that was last seen significantly during the 2008 financial crisis.

Gold prices plunged over 4.5% on Friday, with precious metals joining a broader market selloff as investors liquidated positions to meet margin calls in other assets.

Investors were cashing out to cover losses and meet margin calls in other markets. This does not mean that investor attitude towards gold has changed or that investors have started losing faith in the yellow metal. Gold is still perceived as a safe haven asset and shall continue to do so.

And we did not have to wait too long to prove it. After witnessing a drop in prices on Friday, gold bounced back on Monday, as it rose 1 percent.

Even equities had rallied initially  as the Bank of Japan followed the US Federal Reserve in vowing to take action to stem the impact of the novel coronavirus, with Tokyo launching a new raft of bond purchases and continuing to buy stock-market ETF funds.

Bank of Japan Gov. Haruhiko Kuroda said the central bank would take steps to steady markets, and bolster liquidity through short-term lending operations and asset purchases. On Friday, Federal Reserve Chairman Jerome Powell issued a rare, unscheduled statement, emphasizing the central bank’s intention to act appropriately to address the risks posed by the coronavirus.

A second death from the virus in the U.S., has raised fears of a wider spread of the disease domestically and investors are starting to believe that the Fed and other central banks will act to tamp down expected economic shocks from COVID-19, the infectious disease that originated in Wuhan, China late last year and has rapidly spread across the globe.

The global death toll from the illness stands at more than 3,000, and deaths in China stand at 2,900, according to recent reports.

The coronavirus outbreak continued to take its toll on activity as China reported more than 78,800 infections with almost 2,800 deaths so far. Concerns about the global economy mounted as the virus spread in other countries.

 Gold rose more than 1% on Monday, rebounding from a steep decline across precious metals, amid investor hopes the U.S. Federal Reserve will cut interest rates to cushion the impact of the fast-spreading coronavirus.

Expectations for a Fed interest rate cut at the March 18 meeting are rising “and gold’s appeal as a safe haven is still strong” as the likelihood of “further coronavirus problems and upcoming political headlines in the U.S., Israel, South America, Greece, euro zone and Middle East worries are still intact.”

Fed Chair Jerome Powell said that while the U.S. economy remained strong, the coronavirus “posed an evolving risk” and the central bank stood ready to take action if needed.

Following Fed chairman Jerome Powell's statement that the US central bank will "act as appropriate" as the virus poses "evolving risks" to the economy, markets were expecting a certain rate cut when the policy committee would meet on March 17-18

But what happened on Tuesday took the markets by a sudden shock.

Gold prices rose on Tuesday after the Federal Reserve announced an emergency rate cut Tuesday of half a percentage point in response to the growing economic threat from the novel coronavirus.

Spot gold was up 3.3% at $1,643.85 an ounce, having gained more than 1% in the previous session. U.S. gold futures firmed 3.1% to $1,644.10.

The move was the first such cut since the financial crisis. It comes amid a volatile patch on Wall Street and amid a steady stream of pressure from President Donald Trump, who has called for lower rates to stay competitive with policy at other global central banks.

Expectations of rate cuts by the Fed and negative yields in the euro zone, Switzerland and Japan have supported gold prices. Not from a safe haven point of view, but because at least gold does not charge a penalty (which negative-yielding currencies do). So, gold rallied with stocks because at the time it was a risk-on investment.

Prithviraj Kothari is the author of this article. Find more information about Prithviraj Kothari.

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