THE latest strength in gold prices looks set to be short-lived, given that it mainly reflects investors expecting a rate hike in December rather than in the coming month, analysts say.
But there could be more demand for gold in the years ahead as the Federal Reserve manages not just the start of the rate hike, but the pace of the increases. This would also have an impact on inflation, which investors can use gold to hedge against.
When interest rates head higher, so does the opportunity cost of holding zero-yield assets. This makes gold unpopular during a rate hike.
"The recent pocket of strength has been driven by a combination of two factors: perhaps most significantly, the fading probability of a Fed lift-off for September and the current concerns about the Chinese economy, although it is true to say that gold's performance as a safe haven asset has recently been very disappointing - especially over the last year," said Mark Keenan, head of commodity research in Asia at Societe Generale.
Notably, though the weakness in gold in July was driven by money in China moving out of the safe-haven asset and into the Chinese stock market, the reverse has not clearly been the case as Chinese stocks fell, said Mr Keenan.
Indeed, physical gold demand in the second quarter of this year was at its weakest since 2009 - down 14 per cent compared to a year ago - as Chinese buyers stayed away from gold as the Chinese stock market has offered stronger returns, showed data from Thomson Reuters' GFMS Gold Survey.
"Institutional investor interest in gold, as with commodities in general, has remained in the doldrums for much of the year and options volatility suggests that most speculators are increasingly worried about declines in gold pricing," added the report.
To be clear, gold has floated just under a seven-week high, with spot gold up 0.05 per cent at US$1,148.71 an ounce by 7.06pm (Singapore time) on Tuesday, Bloomberg data showed. But it has fallen some 40 per cent since its record in September 2011.
"These pockets of strength provide a good selling opportunity and in no way alter our overall bearish outlook," said Mr Keenan.
He expects the gold price to head lower over the rest of the year and to average at US$1,050 per ounce in the fourth quarter of this year. His call for gold in 2016 stands at an average of US$1,000 per ounce.
Gold has also rallied by US$66 per ounce since China announced its foreign exchange reform on Aug 11, partly due to concerns that Beijing was deliberately devaluing its currency to benefit exporters, said a HSBC report on Monday. HSBC believed that this has not been the case, since the devaluation was too small to make much difference. "An easing of these concerns may lead to a pare-back in some of these gains."
But UBS's Wayne Gordon, a commodity analyst at the bank's chief investment office for wealth management, noted that over the long term, gold could see some investor interest. "If rate hikes are fairly slow, as we expect them to be, inflation momentum may start to build. As a result, you may see real rates in the US actually going to zero, if not, at negative. That environment is quite supportive of gold," he said at a media briefing.
He added that in this case, US Treasuries would offer negative yields once the market accounts for the higher inflation. Global investors who are risk averse may choose to hold gold to get some pick-up from the strengthening of the greenback against most currencies. Gold prices are denominated in US dollars.