Will gold return with its shimmer?

After languishing at the level of $1,200 an ounce for the majority of 2015, gold zoomed past the psychological barrier of $1,300 an ounce on May 8, 2016, pleasantly surprising investors. In rupee terms, it rose to Rs30,000 per 10 gm on May 6, 2016, from Rs26,000 in May 2015, translating into a return of over 10 per cent.

Although prices fell to around $1,200 on May 30, gold still remains one of the better performing assets in the past one year in comparison to other investments.

Factors behind price swing

If we take a closer look at the trend in gold prices in the current calendar year (up to April 2016), the yellow metal has risen 19 per cent in international and 20.5 per cent in domestic markets, clearly indicating a rising investment appetite. According to a World Gold Council report, the overall demand for gold jumped 21 per cent in the first quarter of 2016 to 1,289 tonnes compared to last year; this has been the strongest first quarter figure on record. The biggest contributor to this growth was the investment demand from ETFs (exchange-traded funds), which surged over 300 per cent in comparision to the same period.

The total inflows into ETFs stood at 364 tonnes, which was the highest in seven years. "The SPDR Gold Trust, the world's largest gold-backed ETF, saw its holdings rise by 33.24 per cent to 855.89 tonnes, indicating regained charm," says Naveen Mathur, Associate Director, Commodities & Currencies Business, Angel Broking. While a portion of the inflows was driven by price momentum and is likely to be more tactical in nature, experts are of the opinion that latent demand among investors, who have been looking for an opportunity to re-enter the market, was the key factor.

According to Mathur, there are various factors that led to an increase in gold prices and investment appetite. A fall in global equities, inflows in bullion funds, interest by buyers due to lower prices, concerns over financial instability and global economic growth, have all been instrumental in pushing gold's price upward. Apart from that, global factors like devaluation of the yuan fuelled fears over the country's economic health and the potential impact on global growth. The Bank of Japan held off another easing move. The ECB also kept monetary policy steady. All this led to uncertainty in global markets and, hence, the affinity towards this safe haven.

The US effect

The much-awaited stance by the US Federal Reserve on raising its key interest rates became clearer with it recently hinting at the probability of gradually increasing interest rates if the economy does well. The biggest jump in consumer spending in April in about seven years could lead to the Fed increasing rates sooner than later.

Typically, higher interest rates lift demand for the US dollar - the reference currency of gold. The US dollar index recently moved from a 15-month low to a 1.5-month high. Gold has an inverse relation with the dollar, which means if the dollar appreciates substantially, it dampens buying in dollar-priced precious metals. The Fed rate hike can also put pressure on gold as commodities don't pay any interest, sending investors in search of higher yields in a rising interest rate climate.

According to Mathur, movements in the dollar index are dependent on economic indicators of the US such as growth in manufacturing activity, employment and housing numbers. Although growth in the US appears to have risen in the first quarter, inflation still remains a cause of concern for the Fed. Wage growth in the US remains subdued, suggesting that the labour market is still slack, although the unemployment rate is at 5 per cent, the threshold as per the Fed estimates for full employment. "Hence, if the rate hike in the US happens, given the employment and the inflation numbers rise in the coming months, the possibility of gold prices heading lower below $1,200 per ounce cannot be ruled out and the volatility will ensure that the price fall is faster than many investors expect it to be," says Mathur.

On the other hand, if the rate hike is delayed in the June Fed meeting (the possibility of which is lower now), gold could cross the $1,300 mark. So, keep your eyes and ears open for these announcements.

Things to Consider

Clearly, gold's path from here on will be impacted by the interest rate policies of leading global central banks, investment demand and price momentum. "Although gold has witnessed a sharp recovery from the multi-year low set last year and market sentiments have changed significantly, the price may remain on a positive trajectory, though there are still some hindrances for a big bull run," says Aurobinda Prasad Gayan, Vice President, Research, Kotak Commodities.

Investing in gold?

Having said that, gold has been a well-performing asset class over the past one year when compared to the average category performance of large-cap equity funds, which delivered a negative return of 2.1 per cent. Mid-cap funds gave a paltry return of 0.5 per cent during the period. The only category that did well during this period was debt funds, which gained 7.9 per cent.

Irrespective of the market direction of gold, an investor should ideally allocate 10 per cent to 15 per cent of his portfolio towards gold as it serves as a safe haven in times of uncertainty and also bears a low correlation with many other assets classes.

If you are looking at gold as an investment and not for consumption, consider investing into ETFs as it is the most efficient form of buying gold. There are no heavy premiums attached to its price or any making charges.

For long-term investors, it is best to stay invested in gold irrespective of price change as the benefits of averaging will be an important aspect for higher returns over a longer period. Systematic investment plans (SIPs) may be an ideal way of investing since they allow you to average your cost and build a corpus for the future. However, if you are looking to buy gold from a consumption point of view, there may be some divergence in prices considering it is affected by other factors such as government duties, making charges etc.