Among the investor community gold is considered a safe haven in the event of crisis. Just as the world started recovering from the recession of 2008-09 it received another jolt from Euro zone, when it was found that Greece was not in a position to honor its debt. Fears among the bankers and institutional investors grew and led the capital flight to the safest “Investment Haven” –
Gold.
Gold also had a sharp uptick considering that most countries considered increasing their foreign reserve with Gold reserves, thereby nudging the price higher due to increase in demand, whilst supply sees no traction. With the recent correction, should we be investing in Gold?
Inverse Relation – Gold & Dollar
Gold is inherently inverse to the Dollar, it is believed that when the strongest nation falls flat, fund flows out of this currency (which is otherwise perceived to be the strongest) into Gold which is a store for value.
When the uncertainty regarding the €750 billion rescue package was hovering over Euro zone gold had touched a high of USD 1235 per ounce. Since then it rose till USD 1259 per ounce, during this brief period, Gold and Dollar defied the traditional relationship between the two instruments. It was found that the spot price of gold was moving in the same direction as that of US dollar, which indicates a high demand for the safe asset among investor community.
Glittering gains – An off-take from troubled waters?
The upside momentum for gold has no fundamental support so the down side risk for gold can be compared with the crude price situation in 2008. crude rose from USD 88 per barrel to USD 145 per barrel and as ever bullishness surrounded this commodity, there were news afloat that Crude could reach USD 500 per barrel mark with the backdrop of ever increasing demand. However, demand alone cannot sustain an imprudent uptrend; the reverse emerged and crude came down to USD 34 per barrel sending the entire investment community into a panic attack.
The point is will this trend repeat in gold and whether gold has completed the upmove. For gold, the dynamics are drastically different, the economies are consistently showing weakness, there is bad news afloat one after the other on the possibility of countries going bankrupt. Gold has always enjoyed the position of being a safe haven – this is precisely what is happening currently. However, over the past few quarters, there is increased cash flow in the virtual gold (ETFs & Mutual Funds) – these are avenues that offer greater liquidity, thereby posing a slight threat in the short term. When things start looking up, there could be huge cash flows out of this avenue – which could see Gold see a rather steep fall, however, this could be only an intermediate situation; once the global economy gets back to its healthy pink self, we could see Gold coming back to its moderate valuations.
Source – World Gold Council; Mn. Tonne
Dynamics of demand and supply
Demand for gold comes mainly from the following four avenues -
o Exchange Traded Funds (ETFs)
o Mutual Funds
o Industrial & Dental
o Jewellery
With growing awareness, virtual gold has had good number of takers, infact virtual is the way to hold gold from a perspective of increased liquidity and lower risk on the global front. However, a closer look at Indian demand statistics has a starkly different story to tell. India scores highest in jewellery demand, there is still a mindset to hold physical gold which will be passed down the generations. Interestingly, there is higher demand seen over the past few quarters within the virtual gold avenues (ETFs & MFs). Here is a snapshot of the demand in Indian scenario
In the graph below, the supply has stayed constant or risen only marginally over the past 4 quarters, however, the prices have seen a sharp uptick.
Source: World Gold Council
European countries – Storm in the tea cup
With the troubled waters over Greece’s public finances and debt contagion fears in Europe rising like never before, the US has led to strong buying of gold coins, bars and exchange traded funds (ETFs) which may produce growth in investment demand in Q2.
Currently, European gold investment demand is exceptionally strong, especially from German and Swiss investors. This is likely to remain so until the tsunami in the form of sovereign debt crises does not cool it’s heels.
Inflation play
Gold is also believed to be a good hedge against inflation, with the increased concerns in India and across the globe, especially china, there has been considerable contribution from this towards increase in Gold prices. Inline with the traditional inverse relation, broadly Gold has held it’s ground against inflation, while faltering only briefly and marginally.
Interest rate impact
Investors should keep a tab on the interest rate scenario in the US; if the US government decides to raise the interest rate then investments in dollar will increase and prices of gold will once again come down and markets will re-price gold. The valuations will clearly come down to moderate / realistic levels, however, with fresh concerns arising due to US housing, it is to be seen if the Fed Reserve will increase the interest rates.
Where from here
Gold is at a critical juncture, it is to be seen which way the breakout will happen. There has been considerable consolidation seen at 50EMA levels, if it breaks out, there could be a smart upswing and this could happen in the background of more worrying news emerging about global economies. However, a breakdown will only see it come back to moderate valuations after a prolonged joy ride.
Conclusion
Gold has already corrected since it peak, the road ahead from here seems to be unclear as it depends on multiple macro economic factors. As long as the turbulence will stay, Gold shall continue to glitter. We have a bullish view of gold over the next year. But as they say, what goes up must come down but even when it comes down it may take a while for economies to emerge stronger and valuations could hold on for a while. However, in the short term, we could see regular profit booking. The best strategy is to buy on dips or invest through a systematic investment process. It is advisable that those of you who were prudent to invest in gold earlier, can book partial profits every time the price does run up! If one gets the opportunity one can average out and buy back on dips.
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By Anil Rego
Anil Rego, an MBA and CFA degree holder, has worked for Wipro as Business Planning and Merger and Acquisition Manager before starting Right Horizons in October 2003. Right Horizons has branches across Bangalore, Chennai and Hyderabad. He is also a Guest Lecturer with various business schools like ICFAI, ITM and Union Bank School of management. Anil has also served as member, Board of Governors, at IBSAF
From Money Control published on July 21, 2010
