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Has gold lost its sheen forever? - Outside View by PersonalFN

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Has gold lost its sheen forever?
Apr 18, 2013

The recent fall in the prices of gold may have left you perturbed and induced you to think, is gold losing its trait of being safe haven and has it lost its sheen forever now. And in this article we'll try to discover the answer whether it indeed has.

Movement of gold since beginning of 2013
Data as on April 15, 2013
(Source: ACE MF Research, PersonalFN Research)

Looking at the above chart, one would be really shaken as price of gold has descended sharply in the month of April 2013 due to signs of economic vigour displayed by the U.S. economy and U.S. dollar too depicting strength. The year-to-date returns of precious yellow metal to are in negative as investors also becoming less risk-averse and a shift has occurred to equities (from gold) attributing to this slide in gold.

The trend over the long term
Data as on April 12, 2013
(Source: ACE MF Research, PersonalFN Research)

But if we observe over the long-term, say over a decade, taking the price of gold in U.S. dollar terms one would observe that trend in the precious yellow metal yet appears secular with a gain of +371% on an absolute basis. Yes certainly, there have been series of correctives in the intermediate but they have been followed by impulses as well and therefore the trend appears secular.

Evaluation of global macroeconomic scenario...

If we evaluate what is happening in the global economy, one would discover that while the U.S. economy is showing signs of economic vigour, the other developed economies - especially the Euro zone is in a situation of debt-overhang and is reporting dismal economic growth. In fact there is a zero-to-negative forecast for many Euro zone economies and thus there are bleak sign of economic revival in the near future. The entire Euro zone economy is facing double-digit unemployment rate (of 12% in February 2013 as reported by Eurostat) and the manufacturing industry is under a recessionary phase and therefore the business confidence too is negative (at -0.86 in March 2013 as reported by European Commission). Hence with gloomy clouds surrounded, the consumer confidence in the Euro zone too is yet low (at -23.50 in March 2013 as reported by European Commission). Now while the European Central Bank (ECB) has kept interest rates near to zero (at 0.75%) in order to reinvigorate growth in the paining Euro zone, it hasn't been able to bring the desired results or send any strong signals either. Going forward there are chances that ECB may reduce interest rates further to help boost recession-hit Euro zone, because thus far interest rate from ECB are higher than that offered by United States, Britain and Japan who have launched massive asset purchase programs with new money and cut rates closer to zero. We are of the view that accommodative monetary policy adopted by the central banks in the developed economy in backdrop of global headwinds, would be supportive to gold in the long term till gloomy clouds of debt-overhang and dismal growth disappear led by sound structural reasons.

Heaping-up gold
Data as on April 15, 2013
(Source: World Gold Council, PersonalFN Research)

In fact recognising that global economic outlook yet looks worrisome, central banks of the world themselves are heaping-up gold as a move to diversify their foreign exchange reserves and that itself tells us that not all's well with the dominant reserve currencies and many are looking at gold as safe haven.

In India too, the domestic economy data appears to be downbeat. There has been a slump in quarter-on-quarter economic growth rate, 'see-saw' movement in in industrial activity, twin deficit problem (occurring on account of ballooning fiscal deficit and widening current account deficit (CAD)), weakness in the Indian rupee, lag in kick-starting of reform despite policy measures being taken and political uncertainty amongst others. While WPI inflation has mellowed in the last three months, frequent upward revisions in WPI inflation, vulnerability from fuel & power inflation (due to partial decontrol of diesel price, which would have a pass-through effect), food inflation and weak rupee may bring in intermediate inflationary pressures.

So in the backdrop of the aforementioned global and domestic macroeconomic scenario, we believe the catalysts for gold are yet active and therefore corrective phases would encourage smart investors to buy more gold, thereby leading to increase in demand. Despite import duty on gold hiked to 6.0% (in order to curb CAD), demand would not deter. In fact that has buoyed-up smuggling activity for 'tola' bars (or unnumbered bars) in the country. Recently the Directorate of Revenue Intelligence (DRI) caught 35.85 kg of tola bars being smuggled into the country from Bangladesh. Smuggling activity in gold has been resurrected recognising the fact that India has an insatiable appetite and flair to own the precious yellow metal, due to various emotional and financial reasons. Moreover this year i.e. 2013, gold buying occasions are 20% more than last year and in ensuing month with 'Akshaya Trithiya' Muhurat (on May 13, 2013) the demand for gold is likely to high. Also with economic uncertainty surrounding the world economy, we think smart investors would view gold as a monetary asset rather than mere commodity and that would keep the long-term trend for gold intact until economic uncertainty recedes. You see, one needs to recognise that gold acts as a store of value, reserve currency, hedge against economic pressures and a portfolio diversifier.

Trend in Gold ETF AUM
Data as on April 15, 2013
(Source: World Gold Council, PersonalFN Research)

The recent trend in the Assets Under Management (AUM) of gold Exchange Traded Funds (ETFs) has been descending, as the sharp fall in gold prices has triggered a sell-off in AUM of gold ETFs. But we believe in the backdrop of what is explained above, we think smart investors would continue to invest in gold ETFs and any corrective move in the precious yellow metal would in fact encourage investing more. Gold ETFs offer host of advantage vis-a-vis the physical form of investing in gold and therefore AUM of gold ETFs has witnessed a steady rise. From Rs 4,800 crore in April 2011, gold ETF AUM is Rs 11,648 crore, an absolute rise of 143%.

Today, one also has a relatively new breed of unconventional way to invest in gold - and that is through gold saving funds (also known as gold funds). Gold funds allow you to invest in gold regularly by enrolling for the Systematic Investment Plan (SIP) mode of investing.

To conclude...

Taking a view of the aforementioned global as well domestic macroeconomic condition, we think that one can take refuge under the precious yellow metal and to add it to your portfolio from a hedge and diversification point of view. This would make your portfolio resilient in the long-term and protect you from economic uncertainties. Whatever your risk appetite is, Gold should always form an integral part of your portfolio; while the debt and equity portion in your portfolio may change according to the changes in the broader market risk as well as your risk appetite and nearness of the goal for which you made your investments. At PersonalFN, we believe that, you should consider your investment time horizon and accordingly allocate 10% to 15% of your total portfolio towards gold. Gold is not an instrument to make quick money but a solid long term asset and hence you should ideally invest in gold with a longer investment horizon.

PersonalFN is a Mumbai based personal finance firm offering Financial Planning and Mutual Fund Research services.


The views mentioned above are of the author only. Data and charts, if used, in the article have been sourced from available information and have not been authenticated by any statutory authority. The author and Equitymaster do not claim it to be accurate nor accept any responsibility for the same. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. Please read the detailed Terms of Use of the web site.

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