US interest rates will likely remain a key driver for gold in the short and medium term. Yet, the negative impact that higher rates could bring will likely be offset by the longer-lasting effects and unintended consequences of expansionary monetary and fiscal policies created to support the global economy.
These may include inflation, currency debasement, and higher exposure to risk-on assets in portfolios. Combined with attractive entry levels, these factors could prompt strategic investors to add gold to their allocation strategies and support central bank demand during the second half of the year.
The first half of 2021 provided a good example of how gold’s diverse sources of demand and supply interact. The gold price dropped by 6.6% in H1, as gains during most of Q2 were thwarted by a significant pullback in late June. Gold’s price also underperformed in most key currencies except for the Japanese yen and the Turkish lira, which weakened against the US dollar.
Overall, gold’s performance was driven primarily by higher interest rates – especially during Q1 and then again in late June on the back of a more hawkish-than-expected statement by the US Federal Reserve. Gold was also influenced by upbeat investor sentiment as the global economy started to recover from the impact of COVID-19.
However, there were supporting factors for gold. Concerns of higher inflation offset part of the drag that interest rates brought. And the strong response from governments to aid economic recovery in the form of monetary and fiscal policies has made some investors worried about currency risks and capital preservation.
In addition, gold benefited from a recovery in consumer demand in Q1, although second waves of the virus and new lockdowns presented challenges in Q2.