The extended rally in gold and silver prices
continues unabated. Riding the rally, gold exchange-traded funds
(ETFs) in India gave their highest ever monthly return of 15% in August 2011, more than the 14% in September 2008, at the peak of the global financial crisis.
"This was not driven by just speculation. Fundamentals played a big role," says Aurobindo Prasad, head of research at Karvy Comtrade. Silver rose 7% in August, a performance which looks subdued in comparison with gold, but is not, considering it had risen 21% in April 2011.
Gold and silver prices generally rise when sentiments on the economy and the financial markets are bearish or there is uncertainty over future trends
You would have been smiling your way to the bank had you been an early investor in the present run-up that gold and silver are witnessing. In the last 5 years, gold and silver have given much higher returns compared to other asset classes.
Thus, if you had invested Rs 1 lakh in gold in September 2008, it would have fetched Rs 2.3 lakh in September 2011. The same investment in silver would have earned you Rs 3.2 lakh. These are huge sums considering that equities have returned only 4% a year in the last 3 years on a compounded basis, while debt has returned 7%. Will this trend continue?Why this rush?
Amarsingh Deo, head of Commodities & Currencies Research at Aditya Birla Money, says gold has been supported by a sharp increase in demand, mainly for investment, and the global economic situation, especially the debt crisis in Europe. The latter has led to an increase in demand for gold as a portfolio diversifier.
In addition, the US Federal Reserve has hinted it will keep rates low for an extended period, which will lead to higher inflation. This is another positive as gold is considered a hedge against inflation.
Another factor is purchases by central banks around the world, says Deo. If we take a look at data from 1989 to 2007, central banks were net sellers of 400-500 tonnes gold per year. This fell to 30 tonnes in 2009. In the first quarter of 2011, central banks bought 129 tonnes more gold than in the whole of 2010. Deo predicts the trend is likely to continue.Does price matter?
In spite of the relentless rise in prices, gold is behaving like a Giffen good, one whose demand rises with prices, says Prasad.
Jayant Pai, VP & CFP, Parag Parikh Financial Advisory Services (PPFAS), says in any bull market, assets go through phases of consolidation followed by a steep increase. Gold, too, experienced this, said Pai. Hence, after moving in a range for months-it stayed between Rs 20,000 and Rs 22,000-gold has resumed its upward march and various segments of the market have started buying again, he says.
Performance of other asset classes
In fact, the sharp increase in jewellery demand offset the year-on-year slump in investment demand. The standout markets were India and China, where demand grew 38% and 25%, respectively.
Marcus Grubb, managing director, investment, World Gold Council, says strong demand in India and China and lower recycling this quarter show people have adjusted to the high prices and expect the rally to continue.
Silver, experts say, has also gained from investment demand and gold's rub-off effect. There has also been an increase in demand for silver jewellery, which can be due to the fact that gold is becoming out of reach for many.
All this has come with increased volatility. There have been many months when both gold and silver have given negative returns. In November 2008, silver fell almost 20%, while gold fell less than 10%. On August 25, 2011, both fell 7%. All eyes are now on what the US Federal Reserve does to spur the economy. So, we can expect volatility to continue for some more time.Gold-silver link
A lot has been discussed about the relationship between gold and silver and the ratio their prices maintain. The ratio has fluctuated widely between 15 and 100 since the 1970s. Pai says it does not have much use as the price of each asset is usually independent of each other.
Break-up of historical data for gold demand
It can at best be one of the many indicators one can look at, he says.
In April-May 2011, it touched 34 after silver reached a record of $50 an ounce, while gold remained an underperformer. Prasad says one can expect the ratio to improve from the current range of 44 ($1,800 per ounce of gold Vs $41 per ounce of silver) as gold outperforms silver.Should you invest?
Karvy's Prasad says investors should buy whenever there is a price correction and stay invested for some time to get good returns. At the same time, he advises staying away from equities for the time being. Also, bond yields are not attractive. It may be better to cash in on the volatility in gold, he says.
This is because apart from the above mentioned factors, festival demand is expected around Diwali in late October and Chinese New Year in late December. Gold can rise to $1,990 an ounce, or Rs 29,500 per 10 gm, from where a correction may take place, says Prasad.
Pai of PPFAS says gold can still be a hedge against stocks and bonds. However, a lot of recent buying is positional and not for hedging, he says. Analysts suggest an exposure of 10-15% to gold.
Analysts do not advise investing in silver at present levels. According to Prasad, the metal is likely to see a correction due to global slump in manufacturing and industrial activity. Due to high volatility, a 10-11% correction can happen any time, which will make silver a good investment, he adds. Pai seconds this view and calls silver an esoteric asset; invest only if you have your mainstream asset allocation in place. Considering that silver has already outperformed gold in the last one year (106% Vs 43%), we may see returns taper off.The ETF option
However, for those who would like to allocate a certain strategic percentage to gold, the monthly systematic investment plan route in gold ETFs appears to be more cost effective than buying directly or the gold saving schemes offered by jewellers. The objective of a gold ETF is to provide gains that closely correspond to returns delivered by gold as an asset class.
There are no surprises. "When compared with holding physical gold, gold ETFs provide investors benefits like affordability, guaranteed purity, high liquidity, transparent pricing and low holding cost," says Mukesh Agarwal, senior director, CRISIL Research. Then there are tax benefits too.
A total of 11 asset management companies offer 11 gold ETFs and 3 gold fund of funds in India.
A number of asset management companies offering fund of funds that invest in gold mining companies, which are expected to gain from higher gold prices. However, Pai says gold mining companies which have over-hedged will lose money in this rally whenever they unwind the hedges.
These companies are also beset with rising labour costs and tighter regulations in some countries. Hence, investing in gold mining companies is akin to a leveraged play on the price of gold, he says. It is better to invest in a pure-play vehicle like gold ETF, he says.
Since silver ETFs are not available in India, one can invest in E-Silver contracts on the National Spot Exchange.