Gold, on hold


In the post-demonetisation era, investing in gold might not be a great idea

Nayan Parmar, an avid follower of gold prices over the past 15 years, has been regularly buying gold on Akshaya Tritiya. Currently, he has nearly 10 per cent of his overall portfolio in gold and wants to increase it to 20 per cent. He thinks that because of demonetisation and the outcome of the US elections, gold might become valuable again. However, he decided to consult his financial adviser before taking a final call. Here is what he was told:

Gold and dollar have rarely moved in tandem

One of the unique features of gold is that it is expressed globally in terms of dollar. The chart on the facing page captures the price of gold in the global markets in terms of $/oz. The measure oz refers to a troy ounce, which is approximately 31.1013 grams. Gold currently trades at $1,127/oz. Ever since Donald Trump became US president, the dollar has rallied sharply on expectations that the US Federal Reserve would continue to hike interest rates. As a result, the price of gold has fallen from $1,300/oz to $1,127/oz in the last one month. Even historically, a strong dollar has been associated with weak gold prices.


Dollar may strengthen further

Nayan thought that as the dollar had already appreciated, it would be appropriate to expect a correction in the dollar. However, his financial adviser said that the Fed is likely to hike interest rates further. Higher interest rates would mean that more investors would prefer to invest in US assets, leading to greater demand for the dollar. Second, Trump is planning to cut taxes sharply and also invest $1 trillion in infrastructure. These will push up growth and spending, making the dollar stronger. So, the dollar could strengthen further, which may not be great news for gold.

For gold to rally, where is the global uncertainty?

This was an absolutely new perspective for Nayan. His financial adviser told him that gold has typically done well in times of financial and economic uncertainty. From 1971 to 1980, for instance, the gold standard was abandoned, there was an oil embargo on the US, the Middle East was at war, West Asia was boiling and the invasion of Afghanistan had brought the US in direct conflict with the erstwhile USSR. During this period, gold moved up from $36/oz to $900/oz, marking one of the biggest bull rallies in the precious metal. Such a situation hardly exists today.

Indian gold prices are impacted by global gold prices and the dollar

Over the last couple of years, the dollar price of gold and the rupee price have largely moved in tandem as the rupee/dollar equation has been largely steady. However, if global gold prices are falling in dollar terms and the dollar is strengthening, Indian gold prices may not fall in tandem. Let us understand this better with an example. The table clearly captures how the domestic price of gold gets impacted by the rupee/dollar equation. While the price of gold has fallen by 16.3 per cent in dollar terms, it has only fallen by 9.8 per cent in rupee terms. Thus, in a falling rate scenario, Indian gold prices do not get the full benefit if the dollar also strengthens versus the rupee. This is something investors need to be cautious about.


Gold is a hedge for bad times, not a choice for good times

The financial adviser said gold has always been a protection against bad times. Hence, a small percentage of money in gold is advisable, as it does not lose value when money starts losing value because of inflation. Hence, the financial adviser feels Nayan should not increase his exposure to gold. Also, demonetisation will be followed by efforts by the government to flush out black money held in the form of gold. This may actually force people to shift out of gold into other asset classes.

Based on the discussions with his adviser, Nayan could infer four points:

* Demonetisation may actually go against gold as the digital shift will force more people to adopt other asset classes like equity and mutual funds.

* The US is showing signs of growth and that is normally the bellwether for global growth. Gold has hardly done well when global economies are growing.

* With the dollar likely to appreciate further after the Fed meet, the rupee could weaken and that will not be great news for the price of gold.

* Gold really does not substitute other asset classes. It is a safe haven for bad times as it does not lose value very rapidly.

Nayan decided to stick to his existing allocation of 10 per cent to gold. In fact, he is also exploring options to convert some of his gold holdings into gold bonds.

Rego is CEO and founder, Right Horizons

This browser settings will not support to add bookmarks programmatically. Please press Ctrl+D or change settings to bookmark this page.
The Week

Related Reading

    Show more