Gold Rush: Gliterry or Jittery?
Gold is an ageless precious metal that has an emotional, financial and cultural value, not just in India, but globally. The metal finds its application in jewellery, technology, and by central banks as well as investors, which leads to the formation of various sectors within the gold market. These sectors rise to prominence at different points in the global economic cycle.
The gold market therefore, is extremely diverse and growing. However, the supply of gold has changed very little over time; increasing by hardly 1.6% annually, over the past 20 years. This diversity in demand and limited/scarce supply forms the basis of gold’s mighty quality as a ‘store-of-value’. The chances of gold, losing its entire value are almost non-existent. This makes it one of the most secured investment options. Apart from this, Gold is highly liquid; it carries no counterparty risk, acts as a diversifier and helps to mitigate losses in times of market turmoil. Also, it acts as an inflation hedge and carries no currency risk. Due to all these qualities, Gold is considered as a safe-haven investment option.
Returns on gold in comparison to other asset classes, over various time periods.
Gold Prices During Pandemic -
Gold has been on a generally positive trend since 2018, but the onset of COVID-19 Pandemic has brought Gold under the spotlight, as one of the best-performing assets, with the price rallying by approximately 17% in the first half of 2020 followed by an additional 10% in July. It hit an all-time high on August 7, 2020, when the price stood at $2072.50 per 28g (globally) and ₹56,200 per 10g (India). However, later, prices have shown a correction from the August 7 high in response to the improvement in the global risk sentiment.
Gold prices in the month of August (per 10g)
Interestingly, the demand for gold jewellery, in the period between April-June 2020, was down 70% (from 213.2 tonnes last year to 63.7 tonnes) and the demand for gold bars and coins was down 32%. Even though sales were drastically low, the price of gold has skyrocketed over the same period.
As per classic economics, the price of a commodity falls, if the sales decline; i.e. if the demand falls, the price too falls. But our yellow metal has defied the classic economic principles during these difficult times, and investors are not even surprised. This is because gold, for ages, has been the most reliable safe-haven investment. Although the demand for physical gold slumped due to the pandemic, the investment demand for gold increased manifold, during the same period. Data from the World Gold Council showed that the investment demand for gold stood at 583 tonnes during April-June, this year, which is almost double from the same time, last year (when it was 295t). Thus, we can say that the investment demand for gold, in the form of gold ETFs and other similar products, has driven the rally in gold prices, during the pandemic.
The demand for ‘Gold ETFs & similar products’ has soared in the first half of 2020
Another important factor that has pillared the rally of gold prices is the efforts being taken globally, to revive the down-turning economy. Several Central Banks, across the globe, are purchasing gold and pumping financial stimulus by means of lowering interest rates or printing currency notes, leading to increased flow of money within the economy. The direct consequence of printing more money is devaluation of the particular currency. This is the exact reason why investors have lately lost confidence in dollar index trading (which is at a two year low). Therefore, in their quest to protect their capital, investors have turned to gold, leading to a sudden spurt in gold prices. Devaluation of the dollar has also lead to inflation, which in fact, supports the rally in gold prices.
In a nutshell, the uncertainty caused due to the pandemic combined with the strategies undertaken to revive the economy, purchase of gold by central banks and the current inflation trend have been the major drivers of gold prices in this year.
Now the main questions here are, Will gold prices continue to glitter post the pandemic? Should investors reshuffle their portfolios and join the gold rush? Here are a few thought-provoking considerations that might change the conventional perceptions of gold.
Although the central banks are printing and infusing more money to revive the economy, this activity cannot continue for a long time. Once inflation reaches the maximum controllable levels, they need to draw a close. Within this period as the economic activity begins to ameliorate, other asset classes (eg. stocks) will also pick up; therefore seeing a shift of investments from gold to these other assets. There are very high chances that this shift will deflate the gold prices in the subsequent years; as the economic activities are re-established to normal. We can get a better insight to this trend, if we observe similar instances in the past.
Analysing Past Instances/Trends:
Global Scenario Gold prices have surged and recently touched all-time highs. A similar rally in the gold prices has been observed during two periods in the recent history – January 1980 and August 2011. The following exhibit shows the Inflation-adjusted price of gold, over the past few decades.
The graph clearly shows the peak prices at the two previous times in history and the price-trend that followed. The major observations here are that if investors bought gold at the two previous highs, they would have lost 55% and 28% over the next 5 years. However, investors who would have bought at the lowest prices would have benefitted. This pattern reinstates the status of gold as a ‘safe-haven investment’ and a ‘store-of-value’ but makes us question the average returns in the medium to long term; which are lower as compared to other asset classes (as shown in the first graph). However, some analysts believe that ‘this time is different’; given the emergence and ascent of gold ETFs.
Firstly, to say Indians love gold would be an understatement. For centuries, households and temples have hoarded the precious metal; not merely as an investment, but also as an adornment and collateral. If we closely observe, the gold price trends in India (in and after August 2011) tell a different story. The drastic slump was not as impactful in India as it were globally. This is majorly because the sharp increase in the jewellery demand offset the year-on-year slump in the investment demand. India saw a 38% rise in jewellery demand in the following year. But we cannot deny there was high volatility in gold prices in those years, due to which the long-term returns were comparatively lower.
Now, what should investors exactly do?
Experts believe that the current rally in gold prices will most likely continue till the economy shows signs of stabilising from the slump created by the aftermath of COVID-19. However, looking at the historical patterns, financial planners and portfolio managers are of the opinion that investors should limit holdings in gold to 10-15% of their portfolio. This is also because of the short-term volatility that is seen in the gold prices, majorly caused due to changes in the global demand and supply patterns and policy decisions of central banks to revive the economy. Also, one needs to decide if it is wise to buy at all-time high prices?
Volatility in Gold Prices , over the past one year.
The bottom line here is, Gold proves to be an unrivalled diversifier and a perennial store-of-value, especially when the market declines. Still and all, investors should not get blinded by this glitter because gold fails to offer higher capital appreciation over medium to long time frame as compared to other investment avenues. In essence, the Midas touch lies not in gold, but in active and efficient money management.