Gold May See Short-Term Dip on Fed Rate Hike, UBS Says

A potential Federal Reserve interest rate hike this month could trigger a short-term drop in gold prices, but the decline is likely to be contained by strong underlying support, according to strategists at UBS. The bank's analysis suggests the precious metal's risk-reward profile remains skewed to the upside heading into year-end.

A 'Knee-Jerk' Reaction Expected

In a note to investors, UBS Strategist Joni Teves said that a September rate increase would likely generate a "knee-jerk correction" in the gold market. This initial downward pressure would be driven by a corresponding rise in real interest rates and the U.S. dollar, which typically move inversely to the price of non-yielding bullion.

However, Teves noted that a decision by the Fed to hold rates steady "would likely deliver a stronger upside response." In that scenario, investors would likely chase the metal higher. UBS believes the market has already priced in a significant degree of monetary tightening, making gold's recent resilience notable.

Underlying Support to Limit Decline

UBS argues that any rate-hike-induced selloff would not "derail the broader recovery" for gold due to several key supportive factors. The bank expects dip-buying from institutional investors and strong seasonal physical demand to provide a floor under prices.

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Key pillars of support identified by the bank include:

• Robust central bank buying: Official sector demand remains intact. China, for example, added approximately 20 tonnes of gold to its reserves in August, bringing its total purchases this year to roughly 80 tonnes.
• Improving investor sentiment: Holdings in gold-backed exchange-traded funds (ETFs) are gradually rebuilding, and trading activity in China is improving.
• Seasonal demand: The approaching festival season in a key market like India is expected to boost physical purchases.

Market Outlook

While gold may still be vulnerable to hawkish surprises from the central bank, UBS believes the asset is now "increasingly more sensitive to positive catalysts." Teves wrote that risks into the Federal Reserve's decision are two-sided.

Despite the potential for near-term volatility, the bank's overall assessment is that the risk-reward for gold is skewed higher for the remainder of the year, supported by fundamental demand from multiple sources.