Both Goldman and gold are related to one another, not just in terms of the latter being a subset of the former in terms of spelling, but on account of their links with the financial markets. Goldman had the markets in a tizzy with different stories of impropriety, while gold has enjoyed the benefits of turbulence in the forex market with the euro crisis sending conflicting signals.
The parabolic movement in the price of gold has helped it reach a new high, and while one may be hesitant to take a price view today, it will most certainly remain volatile with this ?uncertainty?. The sudden increase in the price has been caused ostensibly by the Greece crisis or rather the more pan-euro crises with Portugal, Ireland, Italy and Spain also included. The crises have made the dollar stronger, again, for no particular reason except that investors are moving away from the euro and towards the dollar. It is more the euro weakening than the dollar strengthening. A weak euro means that substitutes are needed. And with the dollar also being under pressure as the fundamentals in the US are not too robust?combined fiscal and current account deficits are still high at 14.3% of GDP?it is not surprising that investors have channelled their funds into gold, thus driving up its price.
Conventionally, the prices of gold and dollar move in opposite directions. Gold is a substitute for the dollar and as the dollar weakens the price of gold moves up. In the beginning of the year, the coefficient of correlation between the two was high at 0.90, but has now turned -0.23 as both the dollar and gold have been strengthening, which is quite atypical. This is unusual and the question to be asked is whether this will last for long?
Efficient markets dictate that prices should be mean reverting and one of the two has to go down. The time period is, however, uncertain and the die has not yet revealed in whose favour it will roll. If gold has to increase in value, then the dollar has to fall, which is likely, though the time frame cannot be predicted under the current circumstances. The euro apprehension will remain for some time even though a $1 trillion rescue package has been announced. The story takes a further sinister turn as there is talk of whether the euro will survive?there is speculation of some countries being asked to exit the common currency. If this were to happen then gold will be the main beneficiary.
As of now, the answer is at best a shoulder shrug, which means that gold will remain attractive till then. This thought is buttressed by the trading on COMEX, where futures trading in gold have multiplied. ETFs have also started pouring money into gold and, hence, there is demand for both real gold and paper gold. Germany, in particular, has witnessed a sudden increase in demand for gold coins with scepticism being expressed over the future of the euro. It must be remembered that the German public and government was not in favour of a Greece bailout, to which the government finally acquiesced.
There is also further reason to believe that one can be bullish about gold since demand is expected to pick up further as investors use gold as inflationary protection. Inflation worries seem more real now with China and the Asian economies expected to grow faster this year along with the US, which will increase the probability of higher inflation.
Closer home, curiously, demand for physical gold at the retail level has decreased, despite the festival season, on account of high prices. India is the largest consumer of gold in the world and has actually witnessed a decline in demand in the recent bull phase. It is, hence, more of the investor-speculator category that has leveraged the conditions in the market as witnessed by high levels of trading in the ETFs on NSE as well as gold futures.
Add to this the emergence of a kind of carry trade that has emerged where investors are shorting the euro and buying gold, thus adding to demand for the metal. This kind of a scenario is likely to prevail for the next few months until there is a clearer picture on the state of the euro economy. Unless there is more gold mined or sold (by the IMF), supplies are unlikely to increase in the short run, which will keep the metal prices in the upper terrain for some time. But, going beyond the crisis, there seems to be no clear reason to expect gold to continue this kind of a buoyant run. A correction will be in the offing anytime after the smoke subsidies.
The author is chief economist, CARE ratings. These are his personal views