Big Story| Gold rally: Going strong or petering out?

For the past two years, gold has been one of the best-performing asset classes.

In rupee terms, it gained 24 per cent in calendar year 2019 whereas the Nifty 50 gained 12 per cent. The year-to-date return of gold in 2020 stands at 34 per cent in rupee terms, whereas the Nifty 50 has produced almost nil returns.

The yellow metal, which was largely trading between $1,150 and $1,375 a troy ounce between 2014 and 2019, has come a long way since then.

Initially, the rally was triggered by the fear of the global economic slowdown with central banks stockpiling gold reserves.

Developments in the US-China trade war and Brexit were sources of geopolitical uncertainties, which later added fuel to the fire.

While the global economy was already struggling to produce meaningful growth, it was hit by the coronavirus outbreak. What initially appeared to be an epidemic within China, became a global pandemic in early 2020, fanning fears across the globe. Countries across continents announced nationwide lockdowns, impacting economic activity.

As a result, stock markets turned volatile and bond yields plunged as investors flew towards safety.

Gold, considered a safe haven, seemed to be an attractive proposition from the perspective of wealth preservation and portfolio diversification and thus held up well amid the turbulence.

Huge liquidity measures were announced by central banks across the globe to mitigate the potential economic impact of Covid.

This, too, became a major factor in driving the price higher. The precious metal recorded a fresh alltime high of $2,075 in August 2020. At its peak, the yearly gain in 2020 stood at about 36 per cent. For Indian investors, the gains at its peak of ₹56,018 were 43 per cent in terms of rupee.

However, after hitting this peak, sentiments towards gold have turned somewhat tepid, with global gold prices softening to $1,900 levels.

So, is the recent bull party in gold petering out or is it just getting started? Let’s look at how some of the drivers for gold prices are shaping up.

Central bank stimulus

Global gold prices, in recent years, have been quite heavily influenced by investment demand, which in turn is linked to global liquidity flows unleashed by central banks.

All financial assets which witnessed a rampant sell-off in March 2020 swiftly recovered post the announcement of relief measures by countries to bail them out of Covid-19. Central banks resumed their policy of persisting rate cuts and infused substantial liquidity into their respective markets.

Among the major central banks, the Fed has announced a stimulus of $3 trillion, the European Central Bank (ECB) €1.35 trillion ($1.6 trillion), Bank of England £745 billion ($1 trillion), and Bank of Japan ¥110 trillion ($1.05 trillion). This renewed rush of money injected into asset markets has helped gold prices make strong gains since March as investment demand spiked.

The price, which was at around $1,570 by the end of March shot up to $2,075 within a span of five months.

Similarly, in rupee terms, it spiked from ₹40,989 to ₹56,013 in the corresponding period.

Notably, investment demand during April-September this year rose to 1,080 tonnes compared with 703 tonnes during the same period last year.

Right now, central banks are open to further liquidity infusions if needed. The recent second wave of the pandemic, especially in the US and the euro region, is making the case stronger for more such stimulus measures. Notably, Germany and France have announced nationwide lockdowns, impacting the pace of economic recovery. If this is followed by more stimulus, that could be positive for global gold prices.

A low interest-rate environment also makes fixed-income instruments less attractive and gold a better alternative as investors see it as a good vehicle for wealth preservation.

Higher inflation projections

Gold has traditionally played a key role in hedging against inflation, by preserving the value of investors’ holdings better than paper money.

Recently, economic forecasters around the world have been repeatedly caught by surprise by the re-emergence of high inflation. Supply bottlenecks caused by Covid-19, sudden shocks to global agricultural output this year due to weather changes, and an emerging La Nina are some of the factors that have propelled agri-commodity prices higher globally, stoking food inflation.

The Fed, in its latest economic projections, has revised inflation expectations upwards. While core inflation in the US in 2020 is expected to be 1.5 per cent (50 bps higher than the previous projection), it is tipped to inch up to 1.7 per cent in 2021 (20 bps more than the previous projection).

Similarly, the ECB expects the inflation in the region to be 0.3 per cent in 2020 (in line with the earlier estimate) and 1 per cent in 2021 (20 bps higher than the earlier estimate).

Likewise, inflation in India has been persistently high since the beginning of the year. In September, the CPI inflation was recorded at 7.34 per cent.

The expectation of an increase in inflation rates in the coming months, stoked by stimulus and monetary easing, can be expected to keep gold at elevated price levels, given its role as a hedge against inflation.

Growth crisis

Most financial assets, be it stocks or bonds, yield higher returns when the global economy is growing at a fair clip. Gold, however, is a go-to asset in recessionary conditions. Be it the global financial crisis in 2008 or the European debt crisis in the following years, investors chased gold for safety, resulting in successive years of double-digit gains.

Gold price behaviour in 2020 has been driven by similar safe-haven demand as the unavailability of treatment protocols for coronavirus forced nations to consider nationwide lockdowns as the only measure to halt the spread of the virus.

As economies came to a standstill, gold prices rallied by 23 per cent and 25 per cent in terms of dollar and rupee, respectively.

But recent developments indicate that some economies might be gradually getting back to normalcy in the aftermath of Covid-19. High-frequency indicators such as industrial production and the Purchasing Managers’ Index (PMI) of major economies have picked up considerably.

In the US, industrial production recorded a historical low in April as it registered a negative growth of 11.2 per cent. Latest data show improvement by recording negative growth of 0.6 per cent in September.

Likewise, the euro region, which marked a contraction of 17.2 per cent — also a historical low — in April, has improved by registering a growth of 0.7 per cent in September.

Similarly, the manufacturing PMI of US recovered to 59.3 in October from 41.5 in April, whereas in Europe, it bettered to 54.4 in October from 33.6 in April. (While a number above 50 indicates expansion, one below 50 indicates contraction.)

A quick normalisation of the global economy post-Covid should temper gold prices. However, this is not a given. The ‘World Economic Outlook’ by the International Monetary Fund (IMF) published in October calls for caution. The report warns that the expected GDP growth of advanced economies in 2021 is likely to be lower than expected.

Global output growth in 2021, which was expected to be at 5.4 per cent, has been accordingly revised down to 5.2 per cent in 2021.

Among the major economies, the expected growth in US has been revised down by 140 basis points (bps) to 3.1 per cent, whereas the expected growth in the euro area has been revised down by 80 bps to 5.2 per cent.

But interestingly, the revised figures are better for China and India, two of the major consumers of gold. While the projected growth in China is retained at 8.2 per cent, India’s growth is expected to be at 8.8 per cent, an upward revision of 280 bps.

Going ahead, if the global economy can come back on track on a sustainable basis, it can bring back the risk-on sentiment which can weigh on the price of gold. But then again, a lot depends on the curve of new coronavirus cases, especially as winter approaches.

Geopolitical developments

Geopolitical flare-ups have always been one of the key factors leading to sudden gold price spikes. Two major developments to watch for on this score are the US-China trade tensions and the Brexit negotiations.

With the US election beyond us, the focus will now shift to the US-China relationship. Efforts to progress from both ends need to be seen to bring back the positivity.

Across the Atlantic, there was no meaningful progress in Brexit talks last week. Uncertainties remain as concerned authorities are yet to find a common ground on issues such as fisheries and competition rules.

As the Brexit transition period ends on December 31, 2020, little time is left to strike an acceptable deal.

As long as uncertainties remain on the above issues, gold price bulls can rest easy.

Physical demand and supply

The extraneous factors influencing gold prices are many. But as a commodity, it cannot escape the forces of demand and supply.

The global demand for gold in 2019, at 4,387 tonnes, was largely the same as the year before, but 2020 has seen a dip in physical demand.

Compared with a demand of 3,303 tonnes in the first three quarters of 2019, gold demand during the corresponding period of 2020 stood at 2,972 tonnes, a drop of 10 per cent, according to World Gold Council (WGC) data.

While the investment demand during this period increased substantially, from 1,000 tonnes in 2019 to 1,630 tonnes in 2020, jewellery demand tumbled from 1,532 tonnes to 904 tonnes.

Moreover, central banks, who had been the major buyers in the past two years, barely showed any interest.

Demand from this source halved during the January-September period of 2020 compared with the same period of 2019 — it declined from 528 tonnes to 220 tonnes.

There has been a notable increase in supply, too. Consequently, the quarterly global gold surplus in Q3CY2020 hit a record high of 331 tonnes, acting as a drag on the price.

But while jewellery demand is tepid, investment demand from gold exchange-traded funds (ETFs) stays solid. The first three quarters in 2020 witnessed a demand of over 1,000 tonnes versus 375 tonnes in the same period of 2019. T

he assets under management (AUM) of physically backed gold ETFs by the end of September 2020 stood at 3,880 tonnes globally, increasing from 2,876 tonnes by the end of 2019.

On the other hand, net long positions on the COMEX have been coming down as money managers have cut back on their longs. The positioning, going forward, will depend on how central banks act, and the December meetings of the Fed and the ECB will be keenly watched.

While more stimulus measures can invite fresh longs, a disappointment in the form of lesser-than-expected or no additional stimulus can lead to a further scaling down of positions.

This can have a similar effect on the ETF demand as well.

Should you add gold?

While the prevailing circumstances may not warrant a sharp decline in price, gold price returns can slow if a vaccine for coronavirus is developed, Sino-US trade tensions ease off, a Brexit deal is struck, or the global economic recovery is quicker or stronger than anticipated.

However, these factors need not discourage you from owning gold in your portfolio as an insurance against inflation or crisis in other asset classes.

With no or very low correlation with other asset classes, it can be an effective diversifier, performing well when other investments don’t. Rather than adding more gold to your portfolio because prices have run up or cutting your gold holdings when it doesn’t perform, it makes sense to maintain a constant allocation of, say, 10 per cent of gold in your portfolio to smoothen out its returns in the long run.

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