The Hindu Business Line : ‘Gold has become a mainstream asset class’

AIG is the second fund house in India after DSP ML fund managers to launch a World Gold Fund, a scheme which seeks exposure to gold mining companies globally. Business Line caught up with Mr Ravi Mehrotra, Managing Director and Head of Asia Asset Management Companies, AIG Investments.

In an interview, Mr Mehrotra shares his views on the gold prices and the how global economic scenario has augured well for gold demand.

Excerpts from the interview:

What is your outlook for gold now as it has cooled off from the highs?

Gold has got very long cycles; ups and downs tend to be for typically 20 and 30 year periods. We are now seven-eight years into the cycle. So depending on which way you look at it, you could be in the one-third or a mid-cycle.

In nominal terms (at $900 odd dollars an ounce now) the previous high was $650 in the 1980s.

If you take into account inflation then the equivalent price of that now is $1800. So if you look at where you are in a cycle then it also in some sense reaffirms the direction in which or the potential to where gold can go.

What drives gold prices?

The other couple of things that really makes a difference to gold are that it is counter cyclical to the US dollar.

So if you expect the US dollar to weaken, then gold moves the other way and appreciates.

Gold is also a store of value and therefore in times of geo-political stress or calamities in markets or during times of inflation (because of inflation gold price goes up).

You’ve got multiple drivers for why gold is a good investment technically. We are seeing a lot of the above playing out now.

Central banks around the world are worried about inflation. There is financial stress….the sub-prime credit crisis.

These make a good case for gold price to look good. While it’s hard to see very far off, the next two-three years is likely to be a good period to be in gold.

Overall gold is a good diversifier with reasonable good returns over long period of time and low volatility.

But how much of the present demand would be a bet against the dollar and what proportion would be speculative in nature?

I don’t know how much. But I did observe that when gold went from $900 to cross $1000, (gold) stock prices didn’t move.

So investors who buy into a gold mining company would have taken a fundamental call.

There must be some speculative element driving the prices….but is it a whole bunch?

We don’t think so. But there would be some shorter-term trades.

What has led to the current investment demand for gold?

If you look at some of the data we have, the amount of gold ETFs in the world in October 2003, just 4.5 year ago, was fractional at less than 20 tonnes of gold. Now it is at 800 tonnes.

Most of the investors who come into gold ETFs are in the US or the more developed pockets.

There are two reasons for the demand: With the creation of ETFs we’ve actually seen more demand for gold as a financial asset. Previously, one had to buy the physical gold and keep it in store.

The convenience of ETF appears to have driven investment demand for gold.

The second is that there are a number of institutional investors in the world such as pension funds that are not allowed to hold hard assets - they could not buy a brick of gold.

But they can buy financial assets such as ETFs.

So they have also started diversifying. So in substance, we are seeing gold becoming a more mainstream asset class than before.

Another interesting fact that our portfolio manager brought out is that all the gold in the world if put into a room would fit in an area 60 ft high and 60 ft wide.

That’s all the gold that has been mined…that’s finite. Total value of that is about $5 trillion today.

The equity markets are $50 trillion in value. So as an asset class it is very small.

The other aspect is what is the amount of gold in the ground? The estimate of proven reserves of gold across the globe is about 41,000 tonnes.

Annual consumption of gold is about 2,500 tonnes. This essentially means that of what we know, there is gold only for the next 18 years. Of course there will be more exploration and more gold discovered.

But it is not as if there is an indefinite supply of this commodity.

It has got fundamental underpinnings and good demand supply making a case for investment.

Since you invest in gold mining companies, what is the outlook now? How does the leverage work?

Thumb rule is roughly 2:1. That tends to be the advantage of a gold mining stock versus ETFs. You get that ratio of 2:1 because of operating margins.

But I must also point out that it works the same on the downside as well. So when gold prices come down gold mining stocks fall more. Investors should therefore be convinced of the trend.

We are looking at gold price appreciation over the next two-three years at least. The second is that this is meant to be a diversifier, which essentially means that one cannot put all their funds in gold.

About three-six per cent of a portfolio should be in this commodity whether one wants to put in gold ETFs or stocks of gold mining companies. That’s the recommended range.

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