With prices falling, should you invest in gold?

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Published: July 24, 2015 11:23:39 AM

Experts say investors should take it as an opportunity to accumulate gold as part of their asset allocation rather than sell out holdings and exit.

goldExperts say investors should take it as an opportunity to accumulate gold as part of their asset allocation rather than sell out holdings and exit. (Photo: Reuters)

Domestic gold prices plunged on Friday to their lowest level in nearly four years tracking losses in global markets.

At 4.46 GMT, the benchmark August contract on the Multi Commodity Exchange was 0.75 per cent lower at Rs 24,548 ($383.92) per 10 gram. It hit a low of Rs 24,533 rupees, the lowest since August 2011, earlier in the day.

The recent drop in gold prices to a four-year low level has come as a dampener to a large number of investors who had witnessed it outperform between 2002 and 2013.

If falling gold prices over the last couple of years reduced its attractiveness, a sharp rise in domestic equity markets in the calendar year 2014 has further reduced its charm. Over the last one year, while the rise in stock markets resulted into incremental fund flows by retail investors into equities, the demand for the yellow metal was on a decline and even the gold exchange traded funds run by mutual funds witnessed net outflows from their schemes.

Though the sentiment around gold remains weak and prices are expected to remain low in the near future on account of strengthening dollar, experts say that investors should take it as an opportunity to accumulate some gold as part of their asset allocation rather than sell out their holdings and exit because gold is an investment that preserves its value in the long-term and provides protection against inflation.


Concerns around gold

Having breached the Rs 33,000 per 10 grams mark in August 2013, gold has already lost close to 25 per cent of its value in less than three years and has fallen below the Rs 25,000 mark for the first time in four years. The pressure on the metal has been coming from international market where it dipped below the $1,100 per ounce mark for the first time in five years.

If gold experts are to be believed, the prices are set remain under pressure as the yellow metal will only end up being a loser in the event of continuing revival of the US economy.

The dollar has been on a rise following recovery in the US economy and since gold typically has an inverse relationship with the currency, it has come under pressure. Experts feel that because commodities, including gold, are priced in dollars in the international markets, a rise in the US currency makes the commodity even more expensive thereby lowering its demand and prices.

Also a rising dollar makes central banks and other large investors put their money into dollar rather than in gold, which is an alternative, and this further brings the demand and the price of the yellow metal down.


This is not all. Another concern that is weighing heavily on the price is the expected hike in the interest rates by the US Federal Reserve.

Over the last few months the US Fed has been hinting that it will increase the base rate this year and it is expected that the hike will be around 25 basis points. A hike in the interest rates in the country will lead to money flowing into US treasury bonds and diminish the attractiveness of other assets that have not been yielding good returns like the gold. So the metal is expected to further come under pressure on that account.

Another factor that playing a major role is the lack of support from China. While the demand for gold from China had gone up significantly a couple of years ago, the demand has declined since then thereby putting a pressure on the yellow metal.

While the pressure will be more on account of strengthening dollar and hike in interest rates in the US, commodity experts see this pressure to continue in the medium term.

“I think the theory of gold following a long-term bull and bear run is still true. Our house view is that now gold will be in a medium term bear phase and the prices may remain under pressure over the next five years and the global gold price may hit the $1,000 per ounce mark now,” said Rajini Panicker, head of commodities-research, Phillip Capital.

Falling demand in India

While drop in demand globally had an impact on the prices, softening of prices has, in turn, led to a decline in investment demand for gold in India. Gold ETF’s in India witnessed a net outflow of Rs 2,293 crore in the year ended March 2014 and a net outflow of Rs 1,475 crore in the year ended March 2015. While the demand for gold led by investment in India stood at 362 tonnes in the calendar 2013, it halved to 180.6 tonnes in calendar 2014.

“With decline in prices gold will not be a preferred avenue of investment for investors for portfolio diversification,” said Panicker.

However, the demand for gold for jewellery purposes did not see any impact and instead witnessed a rise. In fact, the gold demand for jewellery purposes rose from 613 tonnes in 2013 to 661 tonnes in 2014.

Experts say that a decline in prices leads to a rise in jewellery demand in India and also a fall in price increases the volume of gold one can purchase from the same amount.

What should you do?

Whether gold will be in a medium-term bear phase or not only time will tell, but it is almost certain it will remain under pressure in the near term and that calls for individuals to decide what they want to do with the gold they have and if they are planning to buy gold then what they should do. Financial advisors say that investors should follow the asset allocation and not have more than 15 per cent of their assets into gold.

“Generally Indians are overexposed to gold and over the last decade bull run people would have increased their gold holding. But if there are individuals who hold around 5 per cent or less of their assets in gold, they can look to increase their holding when the prices remain fall,” said Vishal Dhawan, founder, Plan Ahead Wealth Advisors.

There are some who say that individuals who have a high exposure of beyond 15 per cent of their assets in gold, they should look to liquidate some of their gold.

In India gold prices are artificially higher on account of the import duty and so when the import prices go down, the prices in India will go down further and that may open another opportunity to buy.

Buyers should remember that gold prices follow a long bull and bear cycle that extends for almost a decade. So the individuals who would have accumulated gold in the 1990s would have seen a significant rise in its value over the last decade. Therefore, any investment should only be for the long term. It is also important to note that if one if looking to invest in gold then the best way to go is through Gold ETFs.

Exchange traded funds are investment funds that are traded on the stock exchanges. In case of gold ETFs, mutual fund companies invest in gold bullion and thus the ETF tracks the market price of gold.

In case of jewellery purchase, while there are concerns around the purity of gold, investors also lose out on the making charges and other charges that may go up to 20 per cent. Also, while buying gold coins and bars from banks, the cost rises by around 10 per cent on account of brokerage, assaying cost etc. The issue with such purchases is that at the time of liquidation all the additional costs are non-recoverable along with issues of storage and security of the same.

In case of gold ETFs, there are no issues of purity and also the annual expense ratio amounts between 0.5 and 1 per cent which is significantly lower than the cost in case of other forms of gold investing. Additionally, ETFs can be easily liquidated since they trade on the exchange which is not so easy in case of coins.

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