Are you expecting Gold prices to fall further? Read this... - Outside View by PersonalFN

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Are you expecting Gold prices to fall further? Read this...
Nov 15, 2014

Indians can't hide their love for physical assets. Many of us get panic when stock markets are falling. But a fall in gold and real estate prices brings cheer on many faces. People wait for such moment and try to buy then. At present, stock markets in India are busy making new highs while gold prices are hitting multi-year lows. Gold bears are out all over. Haven't you received any downward target for gold? Someone might have even told you that gold would correct further to Rs 23,000-24,000 per 10 grams. This means a correction of another 10% here onwards. By the way do bother to check with them from where these levels come. Besides technical analysis do they have anything to support these levels, do check.

Should you wait for those levels?

PersonalFN believes it is possible that Gold might correct to those levels but waiting for buying any asset at the lowest possible price is a big mistake. PersonalFN is of the view that, investors shouldn't repeat their mistakes. In 2008, many equity investors missed buying in falling markets thinking that bottom may be still sometime away. Valuations were dirt cheap. The result is known to everyone. Those levels look a day-dream now. On these lines should you invest in gold right away? Before you decide upon that, you need to understand why prices are falling and where are they headed.

Why gold is falling?

On back of end of monetary stimulus programme in the U.S.; dollar is strengthening. Gold shares inverse relation with U.S. Dollar (USD). It is expected that, U.S. economy may emerge strong although gradually. On the Other hand, Japan has planned to pump in a massive 80 trillion Yen in its economy to get it back on track. This has sent Japanese Yen to a 7-year low. Falling Yen has further provided strength to USD. On the other hand, European Central Bank (ECB) may also continue with near-zero interest rates for long. It may even announce another round of stimulus package for reviving growth in the region.

Weakening of Gold
Data as on November 06, 2014
(Source: The London Bullion Market Association, PersonalFN Research)
Weak Euro and weak Japanese Yen means strong dollar and strong dollar means weakness in gold prices. This relationship may not be as easy as it looks. And if you are about to draw a conclusion that, gold prices will move down further, you may like to read further.

Let's understand what drives gold prices.

It is needless to say that demand for gold is the biggest factor that determines prices. When the demand is high, prices tend to be high and move even higher. The reverse is also true.

There are 3 faces to gold demand

  • Consumption related demand

  • Investment related demand

  • Demand from central banks
As per the data published by the World Gold Council, Indian subcontinent and Greater China together accounted for nearly 48% of total gold demand excluding that from central banks. Consumption demand from India and China has been lacklustre for variety of reasons.

Strong dollar is hitting the investment related demand and there is no exceptional demand from central banks at the moment. Some of world's largest Gold Exchange Traded Funds (ETFs) witnessed substantial outflows over past few months. Although a few central banks such as that of Russia have bought gold in the recent times, the volume of their buying is not large enough to compensate for liquidation from Gold ETFs worldwide.

The analysis given above may suggest that all three supports of gold have become lame now. The bearish stories of gold might appear more appealing to you. But now let's discuss one aspect about gold demand which hardly people think of.

Gold and economic cycles

If you think that, global recovery and strong dollar would drive gold down; you are undermining the probable revival in demand for gold from consumers. As per data published by World Gold Council, jewellery demand constitutes about 48% of the total demand. Another 10% comes from the industry where gold has direct applications. Investment demand accounts only for about 35% of total demand for gold. Rest is a share of central banks which comes at 7% roughly. Furthermore, jewellery demand is price elastic in India and China. In simple words, this means, jewellery demand rises when gold prices fall and reverse is also true. If income levels in these economies rise and gold prices stay low for sustained times, the jewellery demand may go up. This can't be overlooked.

PersonalFN is of the view that, you should ignore all speculation building around gold prices. Someone might give you a price target of Rs 23,000 per 10 grams but that may not be realised if consumption demand revives in India.

Near term events to watch out for:

  • The Finance Ministry has recently suggested RBI to impose some restrictions on gold imports again, which were relaxed in May this year. If RBI reacts positively to this suggestion, gold imports in India may see more barriers. This would affect the availability of physical gold providing props to falling prices.

  • Swiss Government is likely to decide soon whether to add gold to its reserves. If this happens, gold prices may receive some support.

  • Year 2015 remains the key one for gold as Federal Reserve is expected to hike interest rates in the U.S. That would be another blow for gold prices.
PersonalFN is of the view that things are more complex than what they appear. It's not only about dollar-gold relationship. It's also about demand from India and China. Central banks remain the third important factor. As an individual you may not be able to analyse and keep a track of all 3 forces. Therefore, instead of waiting for bottom, you may start accumulating gold at these levels. Let's not forget, one should have around 10%-15% exposure to gold in his investment portfolio. Rather than market timing, it is the asset allocation that would matter a lot in your success as an Investor.

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

Disclaimer:

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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