Futures & Commodities

Time to buy? Gold experts see a sweet spot for bullion as inflation returns

Key Points
  • Gold can provide investors some real risk protection.
  • Gold prices could rise to about $1,260 per troy ounce by the end of the year.
  • A new tax in India will dampen gold demand in July.

Gold prices might be under pressure from the current "risk-on" environment for equities and rising interest rates, but several analysts expect the price to recover and say the precious metal can provide investors some real risk protection.

Gold is currently trading around $1,210 per troy ounce. During Monday's session it fell to $1,204.45, the lowest level since March 15. Several factors are weighing on the price, including the rising interest rate environment where the U.S. Federal Reserve's hawkishness has pushed up the dollar, which consequently puts pressure on the dollar-denominated metal.

However, inflation in the U.S. may prove beneficial for gold, according to Nitesh Shah, commodities strategist at ETF Securities. Gold is traditionally seen as a hedge against inflation.

"We believe that inflation in the U.S. will remain elevated and will rise above 2 percent. And therefore the real interest rate in the U.S., despite interest rates increasing, will remain quite subdued," Shah told CNBC on Monday.

ETF Securities: Tit-for-tat if US uses defense to curb imports
ETF Securities: Tit-for-tat if US uses defense to curb imports

Shah predicts this will give gold prices an opportunity to rise to about $1,260 per troy ounce by the end of the year. He added that gold provides a hedge against event risks.

"Gold still remains a very good hedge towards event risks and with key events like the escalation of tensions in the Middle East, or the sabre rattling between the U.S. and North Korea, we think that gold has potential to spike upwards should any of these tail events come to the fore," he said.

Gold's current price means also means it is now cheaper for investors seeking insurance against other assets falling, suggests Adrian Ash, the director of research at commodity marketplace BullionVault.

Time to buy?

"Gold tends to do well when other assets do badly, but it does best of all when people lose faith in central bankers," Ash told CNBC via email on Tuesday.

"Gold and silver are highly likely to rise sharply if the sudden consensus that the ECB (European Central Bank) and even the Bank of England might join the Fed in cutting back stimulus evaporates just as quickly when they disappoint," he added.

Mariya Gordeyeva | Reuters

Meanwhile, Suki Cooper, a precious metals analyst at Standard Chartered Bank, also said the current price point is a buying opportunity.

"Gold prices closing in on $1,200 per ounce offers attractive opportunities to buy," she said in a research note published Monday.

But Cooper warned that there are several near-term headwinds which will keep gold price's weak. Firstly, yields on the benchmark 10-year Treasury note are around 2.4 percent, a high last seen in mid-May.

"The pullback in gold has coincided with the rise in U.S. real yields to the year's highs as well as the sharp increase in real yields in Europe to the highest levels in more than a year," said Joni Teves, a UBS strategist, in a research note on Monday.

A woman tries a gold earring at a jewellery showroom in Mumbai, India on October 28, 2016.
Danish Siddiqui | Reuters

Secondly, India's biggest tax reform in 70 years, the Goods and Services Tax (GST), will weigh on demand during July. The tax kicked in on July 1 and increased the tax on gold from 1.2 percent to 3 percent.

"Media reports say that demand fell by 50 to 75 percent on the first trading day in July and foot traffic was lower," said Cooper.

"Initial anecdotes reaffirm our view that demand is likely to be weak at first as challenges over invoicing and inventory are resolved, but thereafter to recover," she added.

The long and short of gold

Despite these headwinds, investor positioning is likely to support gold, according to UBS.

Net long positions – where in investors bet that the price will go higher - in gold have been cut by 53 percent, or 12 million ounces, over the past four weeks, as short positions - bets that gold prices will fall - have increased, according to UBS. This change will limit the market's selling power.

"It is likely to become increasingly challenging to put on sizeable positions considering that gold has already fallen considerably, unless there's strong conviction for a move towards $1,100, which we don't think is the case," said Teves.

"We maintain our view that gold should recover from this latest pullback as the move higher in real rates is unlikely to be sustained and we see longer-term value around these levels."

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