Why gold is glittering this Diwali

This Diwali may turn out to be one of the best in recent years for jewellers. The mood on the street is buoyant after gold rallied by more than 20 per cent over the past year, although there has been a bit of price correction ahead of the festival season.

This has increased the number of footfalls in jewellery showrooms, and jewellers are offering various schemes to boost sales. After a couple of dull seasons, we expect this season to see higher gold sales.

Of course, given the price volatility of recent years, investors may wonder whether gold will yield superior returns going forward. It is a genuine concern: given that the domestic equity markets are hovering close to record levels, so beating returns from that will be tough.

Over the long-term, however, investing in gold has always fetched good returns, while simultaneously offering protection against erosion of purchasing power — either to exchange rate volatility or through inflation.

Gold delivered 15 per cent CAGR returns over the past 15 years; and although it offered negative returns for three consecutive years recently, it has yielded positive returns this year.

Does gold havethe potential to extend these gains in the coming year? Yes, we feel it does. The global economy is going through a phase of anaemic growth, and much of the developed world is sinking into negative interest rate territory. This makes the yellow metal a preferred asset class for investors.

The only risk factor is the prospect of a rise in US interest rates. However, as we have seen repeatedly, central banks tend to fall behind the curve when it comes to interest rates; we believe that even given the recent rise in wages data and inflation numbers in the US, the Fed is in two minds about raising rates, given the weakness in Europe and the impact of Brexit. If rates stay on hold, it is generally good for gold.

On the domestic front, physical demand was lacklustre in the first quarter of 2016, but in the past couple of months, demand has picked up, and some of the inventories that were built up last year have begun to deplete.

This has effectively brought down the discount on domestic prices as compared to the landed price, form around $40 a couple of months ago to almost nil now.

We believe that the larger bullish trend in gold prices is intact, but gold could see intermittent price corrections and an extended period of consolidation before we get any meaningful triggers for a fresh rally.

In the short term, there are no major price triggers, and there could some volatility.

But our optimism stems from the fact that the Fed has projected less aggressive rates hikes in 2017, and the Fed’s ability to hike will be contingent on the outcome of the US elections.

An outcome that favours Donald Trump could induce significant market volatility across asset classes; a risk-off environment will benefit gold.

Given the continuing uncertainty over the election outcome and other global factors, we believe that gold will emerge stronger once the excessive speculative froth is out of the market.

However, in the short- to medium-term, any choppiness will provide an opportunity for long-term investors to capitalise on the fall.

The writer is Head – Commodity & Currency, Motilal Oswal Commodity Brokers. Views are personal.

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