Commodity Analysis

Should you buy gold?

Rajalakshmi Nirmal | Updated on January 13, 2018 Published on March 12, 2017

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At current levels gold appears a good investment. Post rate hike, it may only move up

Until Thursday last week, markets strongly believed that there would be a rate hike at Wednesday’s Fed meet as many of the economic indicators showed positive signs.

But the Labour Department’s job data on Friday took away some of the cheer. US non-farm payrolls rose by 2,35,000 in February. Though this was higher than official estimates, it left some observers, expecting higher gains, disappointed.

Still, better than expected job addition (2,35,000 vs 1,90,000) in February plus revision in non-farm payrolls of January to 2,38,000 from 2,27,000 are positives. Job growth over the last three months in the US averaged about 2,09,000 per month, which is comforting from the Fed’s standpoint.

The previous rate hike was in mid-December and gold then fell sharply and hit a 10-month low ($1,112.9/ounce).

The yellow metal trades at $1,204.6/ounce now, down from about $1,264/ounce in February.

To some extent, the possibility of a rate hike in the upcoming Fed meet on March 15 has already been factored in. But still, when the Federal Reserve actually announces a rate increase, the metal may shed a few more dollars.

But those who have invested in the metal needn’t worry. Technically, till the time the metal doesn’t drop below $1,180/ounce, chances are bright for it to scale back to $1,300 levels.

Gold ended 2 per cent lower last week. But silver and platinum prices were down even sharply. Silver was down 5 per cent (to $17.03/ounce) and platinum lower by 5.6 per cent (to $942.5/ounce).

Though gold drops in the run-up to the rate hike, it has mostly rallied post the rate hike, in the past. This has been repeatedly indicated in this column.

Reasons to buy

In 1994, the Fed funds rate rose from 3.5 per cent to 6 per cent between February and September and gold started moving up just two months into the up-cycle, recording a 4.5 per cent gain by September.

Similarly, in 1999, when the Fed started increasing rates, gold, which was initially moving south, took a U-turn and scaled up after the second rate hike. The US dollar, which was moving up in the six months preceding the rate hike, slumped after the first hike.

In June 2004 again, when the Fed funds rate soared by 100 points between June and December to 2.25 per cent, gold rallied 11 per cent.

If you mull over numbers of the last one year, you will note that the reaction in gold price to US rate hike is the same this time too. Sample this: In December 2015, when the Fed hiked rates by a 25 basis points for the first time since 2006, gold prices, which were trending lower, edged up eventually. From about $1,070/ounce at the time of rate hike, they moved up to $1,200/ounce in February and $1,300/ounce in October.

Again, after the second rate hike in December 2016, too, a similar behaviour was observed in the yellow metal’s price. It hit a low of $1,128/ounce on December 15 and moved up to $1,257/ounce by February 24 — an almost 11 per cent return.

So, if you are a smart investor, you can make money in the period between one rate hike and another. Or you can also accumulate the metal whenever it drops 5-10 per cent, build a portfolio in gold and sell at a later point (may be five-six months into the up-cycle) when your returns may be much higher.

Indian gold demand to grow

India’s gold demand in 2016 of 675.6 tonnes was the lowest since 2009. In the current year, demand may be around 650-750 tonnes, says WGC. Positives are the liquidity in the banking system, good monsoon and a bumper harvest leaving more funds in the hands of rural consumers.

It has also outlined that demonetisation has created a fear of holding paper currencies and more people will invest in gold now.

In a consumer research conducted by WGC in Q1 (January-March) 2016, 63 per cent of respondents in India agreed with the statement I trust gold more than the currencies of countries”and 73 per cent of them agreed that “gold makes me feel secure for the long term”.

Over the long term, gold demand in India can only go up, believes WGC. It says that by 2020 India’s annual gold demand may grow to 850-950 tonnes.

India’s growing population and increasing income levels of the middle class are drivers for gold demand. Indian gold demand shrinks when prices go up, but, that’s not a worry, says WGC as demand in the country responds more to income level than to prices.

An analysis of price and demand data from 1990 to 2015 has shown that in India, for a 1 per cent increase in income per capita, gold demand rises by 1 per cent and for a 1 per cent increase in prices, gold demand falls by 0.5 per cent. For instance, in the period between 2000 and 2010, the country’s annual gold demand rose from 700 tonnes to 1000 tonnes despite a 137 per cent increase in price (in rupee terms) as per capita income increased by 78 per cent.

Spot prices in the Indian gold market moved from a discount of $40/ounce in June 2016 to a premium of $1/ounce in January 2017.

Now, it is at a premium of $1.25/ounce. Jewellers are betting on the good harvest to boost rural demand, but, given that record production in many crops has taken prices below MSP, there is a fear that demand may be muted from rural consumers.

Outlook

Gold price in rupees has given a return of 2.2 per cent so far this year compared to 5 per cent in international gold prices. This is because rupee has appreciated against the dollar.

Going ahead too, there may be no cheer from rupee for a gold investor as it stands solid, showing a very little indication on charts for a sharp slide against dollar (in the short term).

The gold futures contract in MCX is trading at ₹28,366 (per 10 gram), down 2.2 per cent from the previous week.

The contract has to cross the resistance around ₹29,200 levels decisively to rally further to ₹30,000/30,500. Supports are around ₹28,000 and ₹27,500.

MCX Silver closed at ₹40,528 (per 100 gram) on Friday, down 3.9 per cent from last week.

If the contract is able to rise over the resistance around ₹42,000-42,500 levels, in the coming weeks, it can make more gains.

Published on March 12, 2017

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