The yellow metal has made an unexpected recovery as the global economy gets into more trouble. Is it the right time to buy?

Is it the right time to buy Gold?

The yellow metal has made an unexpected recovery as the global economy gets into more trouble. Is it the right time to buy?

 Jinsy Mathew   

The year 2016 has been a painful one for investors so far. Equity markets the world over have been volatile, slipping 5-10 per cent in the first two months. However, there is one asset - - - gold - that has made a strong comeback after lying low for the past two years.

On a year-to-date basis, it has risen 14 per cent in dollar terms and 18 per cent in rupee terms. In comparison, bond funds gave 8 per cent, and the highest yielding fixed deposit returned 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 store of value. This was because it had, over the years, moved downhill, almost in line with other assets. When geo-political factors sent shock waves through financial markets, gold was expected to gain due to its safe haven status, but it did not. This led experts to conclude that gold's "safe haven" status is history.

However, there is a saying that in financial markets uncertainty is the only certainty. Gold, too, confounded cynics, and rebounded strongly, due to several factors. The biggest one was the soured mood in financial markets that made investors risk averse. They turned to gold. Jayant Manglik, President, Retail Distribution, Religare Securities, says,"It's the mayhem in global financial markets that has made investors board this safer asset, sparking an upward march in prices."

However, not everyone in the deal room is convinced about the recovery. Before taking any side, it is better to look at reasons that have led to the rally and see if they will persist in the coming days.

Reasons For Rally

Dragon losing firepower: China's economy seems to have lost firepower. The signs were visible in 2015 itself. The recent GDP forecast confirms the trend. According to the latest reports, China's GDP growth is likely to slow to 6 per cent in 2016/17 from 6.5 per cent in 2015/16. A rebound is unlikely in the near term.

It is common knowledge that any substantial slowdown in this Asian powerhouse has ripple effects across financial markets. That is why equity markets in emerging and developed nations have been volatile of late. The MSCI All-Country World Index, a broad-based benchmark of global stocks, has slipped 20 per cent from its April 2015 highs. It moved into the bear market phase in February 2016.

At a time Chinese equity markets are in doldrums and there is a possibility of currency devaluation, the Chinese are expected to increase gold buying. Commodity experts say early trends of this were visible in the last month of 2015 itself when China's gold imports from Hong Kong touched a two-year high at 111.3 tones. This sentiment is likely to gain further ground and act as a major reason for the rally in the coming quarters.

Fed stance: For the first time in a decade when the US Federal Reserve increased interest rates in December, it hinted at the possibility of four hikes in 2016. However, this looks far-fetched now. Given the instability in global financial markets, the Fed may 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 global financial conditions, local growth and inflation. As a result, experts have started factoring in the possibility of just one or no rate hikes in 2016. A prolonged period of low rates will support gold prices.

The other angle to Fed inaction is the US dollar. So far, the Dollar Index has seen a nominal decline against a basket of other developed market currencies. A weak dollar will be another factor that will support gold.

"Recent weakness in the dollar, which has plunged to three-month lows, is going to support the bullion as investors move from dollar towards gold," says Manglik. Both are considered as 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). The aim is to revitalize the economy by making people spend.

This highlights the economic stress in these countries. There is fear that such a policy will backfire by distorting financial markets instead of helping these nations. Given the integrated financial ecosystem, asset classes have become increasingly sensitive to central bank policies. This uncertainty will help gold as people fear their savings will be eroded if such conditions prevail for more time.

In Gold We Trust

Hedge funds and investors are returning to the market. One of the best ways to gauge investor demand for gold is looking at the assets of the world's largest gold ETF, SPDR Gold Trust. After dwindling for months due to redemptions, the trust's assets have risen to their highest level since March 2015. ETFs have risen 11 per cent on a year-to-date basis, the best since 2009. The inflows, which show investor confidence, have been so strong that the money pumped into the fund since the start 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 demand for gold has risen with trading positions indicating bullish bets by hedge funds and money managers. As on March 1, 2016, fund managers were net longs at 1, 22,539 contracts, compared to net shorts at 17,949 contracts as on December 31, 2015, indicating higher speculative activity.

The Outlook

Chirag Mehta, Senior Fund Manager, Alternative Investments, Quantum Mutual Fund, says while gold remains sensitive to movements in financial markets, its movement will, in the long term, continue to be dominated by US Fed rate action. "Given that the economic health of the US is in question, the Fed could soon tone down projections about rate rise expectations for this year. Thus, investors would do well to recognize the shifting economic landscape by allocating a portion of their portfolio to gold. In this volatile environment and era of experimental central banking, it's difficult to forecast whether gold has touched its bottom. Given the macroeconomic picture, the downside looks limited, and this year will likely be an inflection point," he says.

Kishore Narne, Associate Director of Currency and Commodities at Motilal Oswal, says a key thing to note is that even if gold does not perform well in dollar terms, weakness in most emerging market currencies will support prices in local currency terms. Pricewise, a rally towards $1,280-1,300 an ounce is likely with downside limited at $1,030-1,000, he says.

In spite of all these positives, a bull run is not in order, says Mathur. "The rise is a mid-term phenomenon and cannot be termed as bull run wherein all global fundamentals have been factored in the price. From here on, the interest rate trajectory of the US central bank, demand from China and India, and growth in China and Europe will be decisive," he says. He believes spot gold prices in international markets can possibly move higher towards $1,320 an ounce while MCX gold prices can move towards Rs 30,500 per 10 gm.

The recent Budget announcement of 1 per cent excise duty on imported gold is another factor likely to prop up gold in the near term. This is a negative for the jewellery industry and may lead to a scarcity of gold, propping up prices.

Experts concur that retail investors planning to buy gold can wait for the time being. In the near term, gold is likely to shoot above Rs 30,000 but one can wait for this frenzy to die down. A correction back to Rs 25,000-26,000 levels in the middle of the year cannot be ruled out. That should be used to add gold to the portfolio.

A thumb rule says 7-10 per cent of one's portfolio should be in gold as it helps diversify and anchor one's portfolio during volatile times.