The year 2016 has been apainful one for investors so far. Equity markets the world over have beenvolatile, slipping 5-10 per cent in the first two months. However, there is oneasset - - - gold - that has made a strong comeback after lying low for the pasttwo years.
On a year-to-date basis,it has risen 14 per cent in dollar terms and 18 per cent in rupee terms. Incomparison, bond funds gave 8 per cent, and the highest yielding fixed depositreturned 7.5 per cent. The benchmark Nifty fell 10 per cent during the period.
Till the end of 2015,market pundits were writing obituaries of gold, saying it was no longer a storeof value. This was because it had, over the years, moved downhill, almost inline with other assets. When geo-political factors sent shock waves throughfinancial markets, gold was expected to gain due to its safe haven status, butit did not. This led experts to conclude that gold's "safe haven" status ishistory.
However, there is asaying that in financial markets uncertainty is the only certainty. Gold, too,confounded cynics, and rebounded strongly, due to several factors. The biggestone was the soured mood in financial markets that made investors risk averse.They turned to gold. Jayant Manglik, President, Retail Distribution, ReligareSecurities, says,"It's the mayhem in global financial markets that has madeinvestors board this safer asset, sparking an upward march in prices."
However, not everyone inthe deal room is convinced about the recovery. Before taking any side, it isbetter to look at reasons that have led to the rally and see if they willpersist in the coming days.
Reasons For Rally
Dragon losing firepower:China's economy seems to have lost firepower. The signs were visible in 2015itself. The recent GDP forecast confirms the trend. According to the latestreports, China's GDP growth is likely to slow to 6 per cent in 2016/17 from 6.5per cent in 2015/16. A rebound is unlikely in the near term.
It is common knowledge that any substantialslowdown in this Asian powerhouse has ripple effects across financial markets.That is why equity markets in emerging and developed nations have been volatileof late. The MSCI All-Country World Index, a broad-based benchmark of globalstocks, has slipped 20 per cent from its April 2015 highs. It moved into thebear market phase in February 2016.
At a time Chinese equitymarkets are in doldrums and there is a possibility of currency devaluation, theChinese are expected to increase gold buying. Commodity experts say earlytrends of this were visible in the last month of 2015 itself when China's goldimports from Hong Kong touched a two-year high at 111.3 tones. This sentimentis likely to gain further ground and act as a major reason for the rally in thecoming quarters.
Fed stance: For thefirst time in a decade when the US Federal Reserve increased interest rates inDecember, it hinted at the possibility of four hikes in 2016. However, thislooks far-fetched now. Given the instability in global financial markets, the Fedmay not increase rates. This was clear in the minutes of its January meeting.US policymakers, since the start of the year, have been concerned about globalfinancial conditions, local growth and inflation. As a result, experts havestarted factoring in the possibility of just one or no rate hikes in 2016. Aprolonged period of low rates will support gold prices.
The other angle to Fedinaction is the US dollar. So far, the Dollar Index has seen a nominal declineagainst a basket of other developed market currencies. A weak dollar will beanother factor that will support gold.
"Recent weakness in thedollar, which has plunged to three-month lows, is going to support the bullionas investors move from dollar towards gold," says Manglik. Both are consideredas safe assets in a financial crisis.
Era of negative rates:Several central banks in the developed world have kept interest rates negative(this means depositors are charged for keeping money in a bank account). Theaim is to revitalize the economy by making people spend.
This highlights theeconomic stress in these countries. There is fear that such a policy willbackfire by distorting financial markets instead of helping these nations.Given the integrated financial ecosystem, asset classes have become increasinglysensitive to central bank policies. This uncertainty will help gold as peoplefear their savings will be eroded if such conditions prevail for more time.
In Gold We Trust
Hedge funds andinvestors are returning to the market. One of the best ways to gauge investordemand for gold is looking at the assets of the world's largest gold ETF, SPDRGold Trust. After dwindling for months due to redemptions, the trust's assetshave risen to their highest level since March 2015. ETFs have risen 11 per centon a year-to-date basis, the best since 2009. The inflows, which show investorconfidence, have been so strong that the money pumped into the fund since thestart of the year has already surpassed the outflows of entire 2015.
Naveen Mathur, who is Associate Director(Commodities & Currencies) at Angel Broking, says the speculative demandfor gold has risen with trading positions indicating bullish bets by hedgefunds and money managers. As on March 1, 2016, fund managers were net longs at1, 22,539 contracts, compared to net shorts at 17,949 contracts as on December31, 2015, indicating higher speculative activity.
The Outlook
Chirag Mehta, SeniorFund Manager, Alternative Investments, Quantum Mutual Fund, says while goldremains sensitive to movements in financial markets, its movement will, in thelong term, continue to be dominated by US Fed rate action. "Given that theeconomic health of the US is in question, the Fed could soon tone downprojections about rate rise expectations for this year. Thus, investors woulddo well to recognize the shifting economic landscape by allocating a portion oftheir portfolio to gold. In this volatile environment and era of experimentalcentral banking, it's difficult to forecast whether gold has touched itsbottom. Given the macroeconomic picture, the downside looks limited, and thisyear will likely be an inflection point," he says.
Kishore Narne, AssociateDirector of Currency and Commodities at Motilal Oswal, says a key thing to noteis that even if gold does not perform well in dollar terms, weakness in mostemerging market currencies will support prices in local currency terms.Pricewise, a rally towards $1,280-1,300 an ounce is likely with downsidelimited at $1,030-1,000, he says.
In spite of all thesepositives, a bull run is not in order, says Mathur. "The rise is a mid-termphenomenon and cannot be termed as bull run wherein all global fundamentalshave been factored in the price. From here on, the interest rate trajectory ofthe US central bank, demand from China and India, and growth in China andEurope will be decisive," he says. He believes spot gold prices ininternational markets can possibly move higher towards $1,320 an ounce whileMCX gold prices can move towards Rs 30,500 per 10 gm.
The recent Budget announcementof 1 per cent excise duty on imported gold is another factor likely to prop upgold in the near term. This is a negative for the jewellery industry and maylead to a scarcity of gold, propping up prices.
Experts concur thatretail investors planning to buy gold can wait for the time being. In the nearterm, gold is likely to shoot above Rs 30,000 but one can wait for this frenzyto die down. A correction back to Rs 25,000-26,000 levels in the middle of theyear cannot be ruled out. That should be used to add gold to the portfolio.
A thumb rule says 7-10per cent of one's portfolio should be in gold as it helps diversify and anchorone's portfolio during volatile times.