Gold prices soar. Should you invest?

The yellow metal that was dead as an investment for almost a decade is back. With increasing uneasiness over the trade war and the rate cut fever spreading, thrilling times are ahead for gold investors

Just three months back, we had mentioned in the article “Will gold’s time aayega?’’ that gold investors were switching loyalty to equity, due to the metal’s disappointing returns record, with a 10-year CAGR of 1.5 per cent.

There was sell-off in gold-ETFs globally, and sovereign gold bonds in India found muted response. But things have changed dramatically since then. In the last 10 days, equity and bond markets have seen a trend reversal, forcing analysts to rework targets on gold.

Like Thanos in Avengers: Endgame, did some someone just snap their fingers? Yes, the US president Donald Trump and the central banks seem to have done that.

After the US Federal Reserve’s 25 basis points cut in rates on July 31, a disappointed President Trump, on August 1, announced a fresh 10 per cent duty on $300-billion worth of goods from China. In the next three days, Beijing retaliated by devaluing the renminbi (letting it drop to a 11-year low) and halting purchase of US farm goods. This sent panic waves across the globe.

In the week that followed, three central banks dropped rates. And all three cut rates by a level higher than what the market was expecting. This saw bond yields sink across the globe. The yield of 10-year US Treasury note nose-dived to 1.59 per cent on Wednesday (now at 1.74 per cent). Frazzled investors started shifting bets from equity to gold and the yellow metal did a breathless run to cross the psychological $1,500-mark.

On Friday last week, after moving to a high of $1,509, gold closed at $1,497/ounce. The year-to-date returns for gold is 17 per cent (in dollar terms). In the last week, the metal rallied 4 per cent.

Interestingly, in June, while the dollar was down (from 97.5 to 96), gold moved up ($1,300 to $1,400), but in July, both moved in lockstep. This essentially proves wrong the theory that gold can go up only when the dollar is down. A weak dollar supports higher gold price, but it is not necessarily a pre-condition for gold to go up.

While observers were planning the tombstone script for gold, the metal is back with a bang.

Technical charts have already opened up the possibility of a move to $1,600. If the up move sustains, there is potential to reach higher levels.

Read: Why are gold prices rising?

Trade war morphs into a currency war

The world fears that the US-China trade tiff may turn ugly. After Trump’s fresh tariff on Chinese goods, Beijing allowed the renminbi to weaken to 7 against the dollar. This was to blunt the impact of tariffs on goods exported to the US.

After this, the US labelled Beijing a currency manipulator; this sent jitters across the world about an impending currency war. Then, three central banks — New Zealand, Thailand and India — which had their policy meet during the week, dropped rates to support their domestic industries, considering the worsening relation between the US and China and the damage it could do to their exports.

There is now a risk of other countries too devaluing their currencies. In the days to come, if China weakens its currency further against the greenback, other central banks may also be prompted to drop rates; inflation may shoot up and become the launch pad for gold.

What’s also a positive for gold is that the global economy is already fragile. The IMF, in July, pointed to problems for the global economy against the background of the US-China trade war and the collateral damage that it could cause to other countries. It revised its global growth outlook for 2019 to 3.2 per cent from 3.3 per cent.

While so far there is not much pain for the US, employment data and GDP indicators are comforting, if the trade war prolongs, economists foresee risks of a slowdown or recession in the US next year, with decline in investment, employment and GDP. Exports of the information communication technology sector (that makes laptops, semi-conductors, and micro-chips) will be the worst hit, they say.

The recently-levied tariff (10 per cent on $300-billion imports) on Chinese items, including apparel, electronics and foot wear, with effect from September 1, will hit consumer spending. While so far the US households have backed economic growth, this is going to be difficult now. In China, on the other hand, growth is slowing and has already hit its neighbours— Hong Kong, Singapore, South Korea, and Taiwan. These countries export in large volumes to China.

Investors take flight to safety

With the trade war, investors have become so nervous that they are leaving equities and scooping up bonds. This has pushed bond yields lower across markets. The yield of 10-year US Treasury note nose-dived to 1.59 per cent on Wednesday when China devalued the renminbi.

The yield on the 30-year treasury bond slipped to 2.12 per cent, near its all-time low reached in 2016. The yield on the German 10-year bund too hit a new all-time low. In the UK, both the 10-year and 30-year yields hit record lows.

When bond yields drop, it is suggestive of a global recession that pushes investors to the safe-haven — gold.

This time again, the same has happened. Over the last week, as bond yields dropped and equity markets moved into the red, there has been a rush for gold. Holdings of SPDR Gold Trust – the largest gold-backed exchange traded fund in the US — rose from 823.4 tonnes to 840 tonnes.

Demand for gold ETFs, however, has been going up over the last few months. The report from WGC, in fact, shows that in the April-June quarter, the demand for gold ETFs totalled 67.2 tonnes — double of what was recorded for the same quarter last year.

Interestingly, along with investors, central banks too have been in the queue to accumulate more gold stocks in recent times. Central banks bought 224.4 tonnes of gold in the April-June quarter of 2019.

The total buying by central banks, thus, rose to 374.1 tonnes in the first half of the year — the largest net H1 increase in global gold reserves in WGC’s 19-year quarterly data series.

Large buyers included Poland, Russia, China (up 74 tonnes in first half of 2019 to 1926.5 tonnes), Turkey and Kazakhstan. India’s RBI too was in the list of central banks that added to reserves; it purchased 17.7 tonnes of gold between January and June this year.

Gold, as well as the dollar, are seen as safe- haven assets. But one can’t be sure that the greenback will hold up at current levels. The US dollar index has been around 97.5-98 since last week.

But if trade tensions escalate, going ahead, the negative bets on the US economy may see the currency lose its muscle and leave way for gold to take the limelight completely.

Weak consumer demand not of concern

Across most consumer markets, including India, there is always a drop in consumption when gold prices rise sharply. Over the last month, Indian jewellery demand has been very weak.

 

However, when prices go up on a sustained basis, consumers return to the market, say experts. In India, as the chunk of demand for gold comes from festivals and weddings, demand is not purely price-sensitive.

Drop in demand for jewellery or gold bars should not impact global prices of the yellow metal as it can be offset to a large extent by the demand from central banks and gold-ETF buyers.

In the June 2019 quarter, demand for jewellery was 531.7 tonnes, up 2 per cent over the same period last year. Investment demand was 285.8 tonnes, up 1 per cent, Y-o-Y. This can be broken as 218.6 tonnes from bars and coins and 67.2 tonnes from ETFs. Demand for ETFs in the quarter was up 99 per cent.

Given the huge potential for demand from gold-ETFs during periods of rising gold prices, analysts are bullish of the ETF demand for gold pushing up the metal’s overall demand in the current year.

However, the one not-so-comforting factor in gold’s investment argument is that the supply of gold from mines has been increasing. Global mine production grew 2 per cent Y-o-Y in the June quarter to 882.6 tonnes. This is a record level of global output for a second quarter in a row.

Improving margins make miners produce more, helped by higher gold prices, weaker domestic currencies (for key miners, including Australia, Russia and Ghana) and lower crude prices.

 

Further, supply from recycled gold has also been increasing. Though not to the tune of what was seen in 2010 and 2011 (about 1650-1670 tonnes annually), the amount of gold that comes for recycling from consumers who replace their old gold has been increasing. Supply from recycled gold was about 314 tonnes in the June 2019 quarter, up 9 per cent from the same period last year.

Positive outlook

Given the increased trade tensions between the US and China and more central banks likely to cut rates in the coming weeks, the outlook at this point is positive for gold. Gold bulls are running wild and may well take the metal above $1,510 (the high recorded on August 7) in the coming days, as per the technical charts.

Given that the fundamentals are supportive, it should not take long for the metal to reach $1,525/1,527. Analysts in the market have given a three-month target of $1,600 for the metal. On the downside, there is a strong support at $1400.

Indian investors should invest in gold

Indian gold investors were faithful to the yellow metal for a long time. But in recent years, due to gold’s narrow range-bound movement, many reduced their exposure and took the equity and debt route to investing.

Time and again, we underscore the point that gold is a must-have in any investment portfolio to the extent of at least 10-15 per cent.

During global uncertainty and weakness in equities, gold’s safe-haven status will keep the portfolio returns from sliding into the red. Indian investors have actually made higher returns than their global peers over the last five to ten years because of a weak rupee. But that said, given that gold itself made only about 1.5 per cent returns in this period in dollar terms, Indian investors were not a happy lot.

Many exited gold investments in the last 12-15 months. Were you among them?

If yes, then you would have missed the rally in the metal this year. In rupee terms, gold is up 17 per cent year-to-date. MCX Spot gold index is at ₹37,047/10 gm (pure gold – 24K) now. The yellow metal’s one-year return is 26 per cent. In comparison, equity and debt funds have delivered sober returns.

Sample this: One-year return in domestic market equity large-cap funds is a negative 4 per cent. In the case of mid-caps, it is a negative 12 per cent and for small-caps, a negative 16 per cent. Short-duration debt funds have delivered an average return of 5.6 per cent and liquid funds 7 per cent.

So, it makes sense to be invested in gold always. Given that the metal is highly volatile, you can even consider a SIP in gold-ETFs or, even better, buy some grams of gold every time sovereign gold bonds are issued by the government.

Every year, the government issues sovereign gold bonds and announces the dates in advance.

For 2019-20, it came out with issues in June and July, a third one closed last Friday and the fourth issue opens in September (9-13). These bonds are sold through all commercial banks, post-offices, stock exchanges and the Stock Holding Corporation.

Sovereign gold bonds

For Indians, sovereign gold bonds are the best route to investing in gold. These are issued by the RBI, in denominations of one gram and, in multiples, thereof.

Maximum investment in a year is capped at 4 kg for individuals. Like other forms of paper investment such as gold-ETFs or gold fund-of-funds, here too, your investment will be digital and you need not fret over its safe-keeping.

The biggest advantage with the bonds, however, is that they pay a coupon of 2.5 per cent on the face value of the bond. So, throughout the holding period, you will earn interest income.

The investment tenure of these bonds is eight years. Premature exit is allowed from the end of the fifth year. Investors wanting to exit early can sell the bond in the secondary market.

Keep your investments in gold to 10-15 per cent of the equity portfolio, and, then, as Timon sings in The Lion King, ‘Hakuna matata’ — no worries for the rest of your days.

Published on August 11, 2019

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