Commodities

David Fickling is a Bloomberg Gadfly columnist covering commodities, as well as industrial and consumer companies. He has been a reporter for Bloomberg News, Dow Jones, the Wall Street Journal, the Financial Times and the Guardian.

What the hell just happened to gold? The metal, which rarely moves more than 1 percent in a day, just slumped 3.3 percent to its lowest level since June's Brexit vote.

Run for the Shadows
Gold prices fell off a cliff Tuesday
Source: Bloomberg
Intraday times are displayed in ET.

Analysts pointed to comments in a speech Tuesday by Richmond Federal Reserve President Jeffrey Lacker arguing for higher interest rates. But while gold's slump matches the timing of his speech, the remarks were hardly a shock. Lacker is one of the most hawkish presidents of the Fed's regional banks, pushing for tighter monetary policy even as the U.S. was tipping toward recession in 2006. He won't even be a full voting member of the Fed's interest rate-setting committee until 2018.

Some 12,000 kilometers away and three hours earlier, a much better justification for gold's tantrum was playing out in New Delhi. Reserve Bank of India Governor Urjit Patel cut official rates to their lowest level since January 2011 and gave no sign that he was done easing, in a reversal of the more hawkish stance of his predecessor Raghuram Rajan.

A Load of Bull
It's jewelry, not bullion, that's the biggest driver of gold demand. Share of total demand by end-user
Source: World Gold Council, Bloomberg
Note: Not all years sum to 100% because net selling by central banks and ETFs sometimes cancel out net buying by other parties.

A greater tolerance for inflation spells bad news for gold because, despite the obsession with bullion bars and Krugerrands, it's jewelry demand as much as investment that really drives the global market -- and India typically accounts for between a quarter and a third of the world's consumption of gold trinkets. Even after putting in one of its best performances on record, the 448 metric tons of global investment demand in the June quarter was barely ahead of the 444 tons turned into jewelry -- the worst outcome for that end-use sector since 2012.

Patel's more dovish stance risks hitting gold from two separate angles. All things being equal, an India with a higher inflation rate is likely to have a weaker currency, which should raise the cost of metal for domestic consumers. With prices above the 30,000 rupees ($450) per 10 grams level at which local buyers start to back away, that should hurt demand that's already struggling.

Too High
Indian spot gold prices are already at near-record levels
Source: Multi-Commodity Exchange India, Bloomberg

The first and second quarters of this year saw the lowest level of gold jewelry consumption in India since 2009, according to the World Gold Council, and things don't appear to have improved in the most recent period. Gold imports fell by a third year-on-year in September, people with knowledge of provisional government data told Shruti Srivastava of Bloomberg News Tuesday, continuing a run of weak months.

It Ain't Got That Bling
India's demand for gold jewelry just suffered its worst two quarters since 2009
Source: World Gold Council

Inflation could hurt in another way, too. After two years of poor monsoons, more favorable weather may finally now be lifting farm output to the point where food prices start to fall, giving consumers more money to spend on luxury items. Much of the recent real-term improvement in rural wages has come as a result of declining inflation, not rising nominal income.

Looser monetary policy risks eroding those gains and diminishing Indians' spending power. In urban areas, higher inflation will only succeed in raising the cost of living. In rural areas, it should mainly lift the price of non-food products, since the price of food itself is driven mainly by supply-side factors such as rainfall and agricultural yield rather than central bank policies. 

The highest Fed Funds rate in eight years didn't stop investment demand in the first half of this year outstripping even 2009's panic levels, thanks in part to all that negative-yielding debt outside the U.S.. Similarly, the prospect of another Fed hike may prove to be a less potent factor for the remainder of the year than jewelry demand in developing countries.

Gold's global benchmark may be priced in dollars, but the pronouncements of U.S. central bankers have long stopped guiding its price.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
David Fickling in Sydney at dfickling@bloomberg.net

To contact the editor responsible for this story:
Matthew Brooker at mbrooker1@bloomberg.net