Rise in gold prices supported by strong fundamental factors

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Published: May 10, 2016 5:51:08 AM

The word ‘Akshaya’ denotes something that never diminishes and in India, gold is traditionally considered an embodiment of permanent value.

The word ‘Akshaya’ denotes something that never diminishes and in India, gold is traditionally considered an embodiment of permanent value. Akshaya Tritiya is the second biggest gold-buying day in India and its importance to the culturally-entwined Indian mindset cannot be understated when it comes to purchasing gold.

Gold prices have seen a decent rally, as anticipated, post the US Fed rate hike last year. Investors would be contemplating whether they should be buying gold now, given the sharp run-up in prices post the hike. The rise in prices is not merely gold-plated but is supported by strong fundamental macro factors.

Uncertainty over global central bank policies is deepening. Investors seem to be concerned over eroding effectiveness or far-reaching negative consequences of unconventional monetary experiments like quantitative easing programmes and negative interest rate policies.

Indiscriminate printing of currency seems to be the panacea for these banks, which may prove to be a Pandora’s box in the future.

Central banks globally are addicted to unconventional monetary policies. Global central banks have fewer options and have become less potent and effective in their ability to reach their current goals of boosting economic activity and inflation.

In a desperate attempt to lift demand, they have pulled the rabbit from their hats in the form of negative rates. With about a quarter of the world economy facing negative rates in some form and growth faltering, negative rates are becoming commonplace. Suppressing interest rates doesn’t work either; because all that happens is demand is made to shift from current to deferred consumption. Therefore, this again will neither lift spending nor investments but has a potential to spark a rush to real assets like gold.

We maintain our view that real interest rates will probably stay low even if the Federal Reserve raises borrowing costs in response to higher inflation. However, the Fed will remain cautious as the US domestic growth and global growth continue to be sluggish. If the Fed gets more worried about declining growth and lower inflation and changes its stance by launching a renewed quantitative easing programme, it would give a significant boost to gold prices.

Gold prices have seen a rise this year. Consolidation is normal and healthy after a move like we saw. Any improvement in risk sentiment may also reduce flows to gold. However, given the global macro, downsides in gold would be limited and likely to attract significant buying on any meaningful pullbacks. Fundamentally, gold seems to be on a solid footing as central bankers have again hit the wall. Gold should benefit as central bankers attempt further measures through more newer, unconventional and untested approaches to revive growth.

Having said that, we continue to believe that a positive view on gold is just icing on the cake. The main reason to own gold is the sheer fact that it’s an extremely good portfolio diversifier. There is enough mathematical evidence to prove that gold does help your portfolio in terms of improving returns and lowering risk giving enough substantiation of its usefulness and thereby deserving a place in your portfolio.

For simplicity’s purpose, we consider only two asset classes — equities and gold. For equities, we consider investment in Sensex (without dividends) and for gold it would be gold prices denominated in rupees (without any taxes, duties and levies). We compare different portfolios that are yearly rebalanced: One with 100% equity and the others with varying proportions of gold allocation like 5% gold and 95% equities, 10% gold and 90% equities, 15% gold and 85% equities and so on. Data show that gold helps to reduce risk without sacrificing returns from your equity investments. The important point is such risk reduction enhancement for the portfolio has come without sacrificing the long term return potential. An allocation of 10-15% of your portfolio to gold may be a useful addition to your portfolio and thereby help you to improve the risk return profile of your overall portfolio.

The writer is senior fund manager, Alternative Investments, Quantum AMC

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