Gold which holds the characteristics of being one of the safest commodities of economic uncertain times is currently experiencing a hell of a ride in recent months. The shiny metal is enjoying an uptrend and is currently hovering around the level of US$1930, the level last seen during April last year. This represents an upward movement of more than 7% in the last one month.

The yellow metal has a history of being used as storage of wealth as it is not affected by inflation in the same way like cash and other financial assets do. This was observed during the Covid times when gold breached US$2,000 per ounce levels in global markets. The same was seen during the Russia-Ukraine war when it again broke the US$2,000 an ounce mark.

The performance of gold during tough times makes it an attractive option for investors looking to protect their wealth during periods of market volatility.

Modest rate hikes: a development in the favor of gold

The current market is expecting the US central bank to go for a 25 basis point rate hike in February after a half-percentage point increase in December. On top of this, in December, for the second straight month, consumer prices in the UK fell giving indications that inflation has finally peaked in the majority of Western economies.

These developments which include a possibility of modest rate hikes are pretty much in the favour of Gold as it is highly sensitive to the rates outlook of central banks. Higher interest rate raises the opportunity cost of holding gold, putting investors away from the non-yielding bullion.

Or in other words during the period of high-interest rates the opportunity cost of holding gold, which does not pay interest or dividends, increases. This normally moves investors away from gold as they tend to sell their gold holdings and invest in interest-bearing assets instead.

Additionally, when interest rates increase, the value of the U.S. dollar (in which gold is priced globally) tends to appreciate. This put negative pressure on gold as a strong dollar makes gold costlier for foreign currency holders.

How the budget can impact gold prices:

India being one of the biggest importers of gold holds a high correlation between import duties and gold prices. This is because of the fact that higher import duty increases the cost of importing gold which makes gold more expensive for retail consumers. The increase in cost will therefore reduce gold demand and lower its prices.

On the contrary, if the government lowers import taxes or takes other steps to expand consumer access to gold, it can boost demand and can raise the price of the commodity. 

How Indian commodity investors can use these developments?

The run-up in gold is attracting a lot of investors towards the growing commodity markets in India. The Indian commodity markets hold the future contracts of Gold in the form of Gold (1 kg), Gold Mini (100 gm), Gold Guinea (8 gm), and Gold petal (1 gm).

Along with the future contracts, investors can also use gold futures options which were launched by MCX in 2017.

In addition to the future and option contracts, the investors can opt for MCX’s bullion index, BULLDEX. It serves as an instrument for more conservative traders as it is based on the gold and silver future contracts.

Gold options: an instrument that can limit potential losses

As with normal stock options, gold options give the holder the flexibility to choose whether or not to exercise the option and hence normally considered less risky than futures which have a theoretical potential for unlimited loss.

In addition to this, the risk of loss for options in the case of buying is limited to the premium paid for the option. This capping on the loss makes them a popular mode of instrument amongst the new age investors who look for opportunities with a high possibility of reward with small associated risk.

In essence, futures and options are emerging as attractive instruments for the new age investors who are looking to cash in on the movement in the gold prices especially when gold is hovering around important levels.