Gold Upside Likely On Yen's Carry Trade, Fall In US Bond Yields

There has been multiple global cues and triggers that have pointed toward an upside in gold for a couple weeks now. With the fall in the US bond yields being the overarching factor, the narrowing of the yen carry trade has now boosted chances of a further upside for the yellow metal, according to analysts.

Japan has been the only economy that has maintained a negative interest rate after the pandemic. Intended to incentivise spending and to make capital easily available, the rate had also pushed carry trade.

Carry trade is when the money is borrowed at the available negative rate from one country and invested into treasuries abroad where the risk-free returns are higher. Here, the investors could pocket the difference in interest rates and keep the cycle going.

The factors driving this inflow were the high bond yields offered by the US treasury and the strength of the dollar as a currency. In the past couple weeks, both these elements have changed.

The US dollar index slipped below the psychologically crucial 103 level to a day's low of 102.65 in early Asian trade on Monday as recession fears in the US rose following weaker-than-expected US Jobs data. The yield on the 10-year US Treasury note extended its fall to 3.72%, the lowest level since June 29, 2023.

Since both these factors assuring inflow into treasury have declined, the investors are anticipated to resort to safe haven investments.

On Monday, spot bullion, which rallied close to a record last week, sank more than 1% before rebounding to trade above $2,450 an ounce, according to Bloomberg.

The yellow metal had seen a fall in price after a rate cut in customs duty was announced during the Union Budget 2024.

Gold, being a commodity that is often held by investors to hedge against a possible recession, will gain traction according to analysts. The upside of the commodity will now be driven by global changes like US bond yields and the narrowing to carry trade.

"The world is bracing for a second rate cut in bond yields this year, which was anticipated to be 25 basis points but could now go up to 50 basis points," Navneet Damani, head of research for commodities at Motilal Oswal Financial Services, said. "Dollar has also collapsed, adding fire to gold prices. This adds to the many geopolitical events triggering gold prices."

The reaction to these changes and movements in the global markets is bound to spill over to the domestic market as well. "The local market is active after the rate cut announced and the further upside will be largely driven by the yen carry trade," Anindya Banerjee, head of currency research at Kotak Securities, said.

The yen carry trade might be negative for gold as people might have taken leverage there as Chinese and Japanese currencies are strengthening. A month back, Japanese and Chinese investors were buying gold to hedge against the dollar weakening. These bets will now unwind, reacting to the change and will have a temporary negative impact on gold, according to Banerjee.

The narrowing carry trade will impact the domestic market, but the degree of upside driven by this change may be limited.

Some upside because of the rate hike could be possible, but it is a short-term phenomenon, according to Damani. "How deep the carry trade is and how fast it will unwind is anyone's guess. Not too much credit for it in the gold rally. It has just been pressurising the dollar index for a while now."

Prospects circle back to the US bond rate cut that acts as an overarching larger positive factor for gold. Some anticipate a 50-basis-point cut, which is a perfect launchpad for gold to take off. One can easily see gold prices flying in the short to medium term, but the volatility will remain, according to Banerjee.

An upside of 8–10% from the current rate, which is $2,650, is anticipated within the next 12 months by Damani. He expects that the gold prices might go up to Rs 76,000 per 10 grammes in the next 12 months.

A $2,550–2,600-dollar per troy ounce is anticipated by Banerjee in the next two months. He also expects a more significant upside within a year, going up to $3,000 per troy ounce.

With the anticipated upside for gold soaring, it is important to identify the right avenue and instrument to invest in. There have been no fresh sovereign gold bonds issued so far but there are a couple other avenues that investors can invest into like gold exchange traded funds and gold funds.

"For the higher tax brackets, sovereign gold bonds would still be a good option," Vishal Dhawan, chief executive officer of Plan Ahead Wealth Advisors, said.

Investors who are comfortable holding gold can consider rebalancing their portfolio to hold up to 5% and can also consider Gold ETFs, he said. For investors who would like to avoid price volatility, Dhawan suggests that they invest in gold funds.