Gold is largely imported and hence if the rupee weakens against the dollar, gold prices will likely appreciate in rupee terms.
Gold price in India is currently hovering above Rs 40,000 per 10 gram. With interest rate heading southward and amidst the global crisis especially at a time when the rupee is getting weaker against the dollar, the gold price in India may continue to rise till the factors impacting its movement change. Over the last 2 years, the gold price per gram has generated a compounded annual growth rate of 14 per cent and almost 9.5 per cent over the last 10 years. Generally, gold prices tend to remain flat over long periods and then show volatility over the short-to-medium term.
Most financial planners suggest holding about 10 per cent of one’s portfolio in gold. Such exposure in gold should be ideally through Gold ETFs (exchange-traded funds) or sovereign gold bonds as they represent paper-form of investing in gold. Owning paper gold is much cost-effective than buying physical gold in the form of coins, jewellery or gold bars.
But, if we look at the gold price chart, it shows the price of gold has already moved a lot. What determines gold prices, does gold price in India move in tandem with international prices and most importantly what should investors do now? These are some of the top-of-the-mind questions most investors seeking to invest in gold is seeking answers for. Here is Chirag Mehta, Senior Fund Manager, Alternative Investments, Quantum AMC help us understand them for a better and informed decision making before purchasing gold.
Why, according to you, is the price of gold increasing?
Economic data, globally, is increasingly showing signs of stress. The transition to a low-growth disinflationary environment exacerbated by trade war uncertainty and with it, the next rate cut cycle is fast increasing the appeal of gold in anticipation of falling real rates. As the impact of trade wars impedes economic activity, the Fed seems in a hurry to support the ailing economy eroding long-standing support for the dollar. A further flare-up in US-China Trade war and initial signs of it manifesting into currency war makes gold attractive.
The global capital market’s mood is shaky due to the fear of the unknowns, signs of fresh strains on the global economy may prompt stimulus from central banks. In a way, it seems moving back to yesteryears of loose monetary policies, which led to the last bull run in gold. Central banks have tried to get out of this low-interest-rate trap but they aren’t able to. The market is addicted to cheap liquidity and doesn’t look like that is going to change anytime soon.
As central banks begin to cut rates aggressively or adopt further unconventional measures like QE to support the economy, it will be perceived by the markets that the central banks are caught in a trap and will not be able to normalize monetary policy. This will be a big boost for gold prices.
Unconventional policies like negative interest rates make holding gold a viable alternative to bonds. Indifference toward gold is starting to fade and the metal has been reasserting itself as an asset of choice amidst escalating trade and geopolitical tensions.
Are international prices increasing at the same pace as gold price in India?
International and Indian gold prices are both rising. Indian gold prices have recently increased more than the International gold prices owing to rupee depreciation and an increase in customs duty by the government.
Chart: Gold Price per Ounce
How does a decline in interest rate scenario help in increasing gold prices?
Interest rates are a critical factor affecting gold. Gold does not pay interest. And thus when interest rates increase, gold prices usually soften as people sell gold to free up funds for other investment opportunities that give a higher return. As interest rates decrease, the gold prices usually rise because there is a lower opportunity cost of holding gold when compared to other investments.
There is a good chance that the global economy will enter into a recession within the next 1-2 years. Major economies of China and the United States are showing signs of slowing down, and the trade war between them is accelerating this. Central banks will further cut rates at first signs of recession driving real interest rates lower, this bodes well for gold prices.
As traditional policy options like Quantitative Easing are not generating sustainable economic growth and thus proving to be ineffective. In a desperate attempt to spur the economy and get people to spend money, central banks in Europe and Japan are discouraging commercial banks to park their money with them with the help of negative interest rates.
The amount of negative-yielding debt globally is on the rise. If negative interest rates are continued to be imposed, the nominal price of gold is expected to rise over time. This is because lower interest rates will make holding currencies less attractive, diverting funds to the fallback currency –gold.
Clearly, negative interest rates make holding gold a viable alternative, to a bank account or bond that loses purchasing power, or to bubble-like financial markets that could wipe out your capital.
Our view? Brace yourself for more negative-yielding debt in the near future, and resulting appreciation in gold prices.
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Does a weakening rupee play a role in rising gold prices?
Yes, a weak rupee leads to an increase in gold prices. Over the years, the rupee-dollar equation has had a significant contribution to rising gold prices. Gold is largely imported and hence if the rupee weakens against the dollar, gold prices will likely appreciate in rupee terms. Indian economy is slowing down and often policymakers will strive to stimulate the economy or engineer a depreciation to improve export competitiveness, thereby kick start the economy. Hence, if rupee weakens further, it will lead to an increase in gold prices to that extent.
At higher gold prices, will demand for gold be impacted?
Typically India’s gold imports have been relatively price-inelastic. But it is fair to assume that whenever prices jump sharply, consumers tend to hold back from making purchases until the price stabilises. A similar reaction has hit near-term demand. Prices have continued to inch higher over the years but people get accustomed to high prices as prices stabilize and haven’t seen physical demand impacted over years beyond the short term.
As gold fares well in comparison to other asset class, the indifference toward gold is starting to fade and the metal has been reasserting itself as an asset of choice amidst increasing uncertainty. We expect investment demand for gold to increase which was largely absent over the last few years.
What should investors do now?
We have always advocated that investors maintain their gold allocation in the 10-20% range depending on their portfolio composition and risk appetite. Review your allocation to gold to make sure it remains adequate enough to be able to serve as an effective portfolio diversification tool. The world continues to remain in a state of great disequilibrium, both with respect to the global economy and geopolitics as well. Given the macroeconomic picture, gold will be a useful portfolio diversification tool and thereby helping you to reduce overall portfolio risk. Gold prices are just starting to move out of its 6-year consolidation, so if you don’t have your gold allocation in place, it’s still time to get it right.