Global Outlook

Gold Likely to Lose its Shine

Contributed by Nirmal Bang

By Nirmal Bang

In the last 11 years, gold prices have risen from $280/ounce to $1,920/ounce. In fact, in 2011, gold outperformed most asset classes. There are several reasons for this huge rally in gold. The yellow metal’s role as a store of value continues to gain with the growth in the global money supply (M2).

Gold prices have grown faster than the growth of the global money supply (M2). Since the year 2000, world’s major central banks’ answer to crises have been easy monetary  policies and stimulus packages in various forms. Because of this, real interest rates have turned negative and inflation is constantly moving up (except in 2007-08). Record low interest rates have moved gold and Treasury Inflation Protected Securities (TIPS) higher in 2011.

Historically, whenever real interest rates have been negative, gold prices have done well. It is a notion that gold may continue to gain as global monetary policies remain loose and real interest rates negative. One must not forget that post-1981 till 2000 when real interest rates turned from negative to positive, gold remained under pressure, for almost 20 years.

The demand for gold from India and China has been robust as investors seek to diversify their portfolio; strong growth is also encouraged by demand for jewellery. In India, there is a notion among people that gold prices will keep moving up. But this is not always true.

India, the world’s largest importer of gold, saw a sharp decline in demand, for the first time in five quarters in July-September this year. The demand fell 23% y-o-y from 263.9 tonnes to 203.3 tonnes. Due to a sharp depreciation in the rupee, Indian gold prices have made new highs despite a correction in the global markets. In India, high interest rates and slowdown in growth are seen to be hurting the demand for gold.

One of the most important reasons behind the rally in gold is investment demand. Investment demand in the last 4 to 5 years is one of the major reasons for gold to sustain at such levels. The demand for gold bars, coins and ETFs are important factors that support gold prices.

SPDR Gold Trust’s (world’s largest Gold ETF) holding has surged from 8.09 tonnes on 18th Nov ’04 to 1,309 tonnes on 8th Aug ’11. There has been a robust investment demand, which has caused the yellow metal to move up exponentially. Any cool off in investment demand for a quarter or two may not spell good news for gold.

The debt crisis in the US and Europe was also one of the main reasons for the outperformance of gold in 2011.

The downward revision to US credit rating triggered a massive upside - later seen extending with the crisis in Europe, which spread from peripheral countries to larger economies.

STILL A SAFE HAVEN?

Traditionally, there has been an inverse correlation of gold with  stocks and other risky asset classes. But recently gold rallied with riskier asset classes. It seems as if all asset classes are moving together.

Post-September ’11, when the debt crisis in Europe intensified, a major downside was seen in most risky asset classes. Surprisingly, gold too corrected by more than $300/ounce.

Again with the rally in other riskier asset classes, gold rallied from $1,600/ounce to $1,740/ounce. Even in 2008, when world economies were  reeling under recession, gold prices corrected from $1,000/ounce to $750/ ounce. A similar correction was seen in risky asset classes at that time.

OUTLOOK ON GOLD

Due to any undesirable event in Europe, gold still holds a good chance to bounce back. We are not very bullish on gold from a two-year point of view. Any major rally from here will be a good opportunity to book profits. Gold trading at $1,600/ounce has already discounted a lot of positive news for itself.

The period before dawn is always the darkest. Despite the debt crisis in Europe and the slowdown in China, India and other emerging markets, US economic reports have been encouraging since the last quarter as we have seen an uptick in exports, reduction in jobless claims, moderating unemployment and improved business activity. Recovery in the US is a positive for the dollar. So, we are not very bullish on gold.

The dollar is likely to strengthen in the coming year denting the appeal for gold. Provided there are no more stimulus packages as crude oil is already flirting at $100/barrel, commodities as a complex is likely to witness a correction next year and may find it difficult to breach the highs of lots of commodities and inflation is likely to moderate, which will further dampen the attractiveness for gold as investment. Investment demand for gold may remain subdued and may dampen due to tighter credit scenario. Don’t be surprised to see gold trading between $1,300/ounce and $1,400/ounce in coming years.