Gold prices have been on a roller coaster for the past 5 years. After touching a high of $1900/oz (gold prices are internationally measured in Dollars per Troy Ounce), gold prices fell sharply to touch a low of $1050/oz in early 2016. However, the first Fed rate hike in 9 years effected in December 2015 created a virtual panic among equities and bonds. During this period, the price of gold was up sharply to $1350/oz, making gold one of the best performing asset classes in the first half of 2016. However, Trump’s victory in late 2016 and the Indian government’s demonetization drive led to a fall in the price of gold. It would therefore be interesting to understand what drives the price of gold and what does the current situation hold for the future of gold prices.
What drives the price of gold?
Historically, there have been a few key factors driving the price of gold. Gold prices have been inversely related to the value of the dollar. Therefore a strong dollar index results in weak gold prices. Secondly, gold becomes valuable when there is geopolitical uncertainty as investors prefer the safety of gold. We saw that during the 1970s and later post the Lehman crisis in 2008. Thirdly, when currencies get debased due to too much money getting printed, gold emerges as an alternative currency. Interestingly, while the principal demand for gold comes from India and China, the traditional jewellery demand has rarely driven the price of gold.
How is gold poised to perform in 2017?
Let us look at the outlook for gold on each of the above factors. Firstly, gold demand for 2017 is likely to be better (Indian gold demand had fallen sharply in 2016 as per WGC). However, this demand is unlikely to substantially prop up the price of gold from here on. Secondly, what about dollar strength? According to the Federal Reserve, there could be a minimum of 2 more rate hikes during 2017. Hawkish rates scenario will drive up the yields on US bonds and simultaneously drive up the Dollar. While dollar may not see a runaway rally as in the past, the Dollar Index is likely to show strength.
Thirdly, the question is whether central banks will debase their currencies further by infusing more liquidity into the system. Currently, the US Fed sits on bonds worth $4.5 trillion while the ECB sits on bonds worth €4.1 trillion. This massive bond portfolio of central banks was largely created post-2008 when these central banks infused liquidity into the system by mopping up bonds. However, the narrative in the US is shifting towards monetary tightening which will imply winding up this portfolio of bonds gradually. At some point in the future, the ECB and the Bank of Japan may also follow suit. Therefore, the only major justification for a rise in gold prices will be geopolitical uncertainty. With the US bombing targets in Syria and Afghanistan and sabre-rattling in North Korea, the geopolitical uncertainty could continue. That will mean that gold will continue to be in demand due to its safe-haven quality.
So how do Indian investors go about investing in gold?
To begin with, there is a simple caveat. Gold cannot be classified along with other asset classes like equity, debt and real estate. Gold is, at best, a hedge against global uncertainty. Hence exposure to gold must be restricted to around 8-12% of the total portfolio value depending on the geopolitical situation. But how do you invest in gold?
While buying gold bars and jewellery is the traditionally accepted form of buying gold, there are other more scientific forms of holding gold that are emerging. Sample a few of them
A long term investor in gold can look at buying exchange traded funds on gold (Gold ETFs). These can be bought and sold like any stock in the market by paying basic transaction fee. They are liquid and track the price of gold very closely. It also saves you the hassles of storage, insurance, safekeeping etc.
Gold traders can look to buy futures in the commodity markets by paying a nominal margin. However, one needs to be conscious of the risks involved as gold futures are a leveraged product and just as profits can multiply, losses can also multiply.The government has recently launched the Gold Bond scheme, where you can participate in the gold price movement and also earn annual interest of 2.50%. These bonds are guaranteed by the Government of India and are also traded on the exchanges.
Lastly, you can also participate in the Gold Demonetization Scheme, but that scheme is yet to take off in a big away.
In a nutshell, gold will continue to attract interest from buyers due to geopolitical uncertainty. The basic idea for investors is to purely look at gold exposure from the point of view of providing stability and in in-built insurance for your portfolio.
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