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Updated: April 21, 2013 04:01 IST

After the fall, it is time for gold rush

Lokeshwarri S. K.
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WGC data show that gold investment in bars, coins and exchange-traded products have dropped
WGC data show that gold investment in bars, coins and exchange-traded products have dropped

WGC data show that gold investment in bars, coins and exchange-traded products have dropped

The dramatic drop in domestic and international gold prices over the past 10 days has shaken investor confidence in the yellow metal, even as the gold-buying-brigade throngs jewellery shops. Does this crash signal the end of the rally that began at the turn of this millennium?

To answer that question, we need to look at what drove the gold prices higher from the low of $254 an ounce in 2001 to the peak of $1,920 in 2011. Data disseminated by the World Gold Council show that it was not the demand for gold jewellery, but the demand for investment that spurred this rally. Gold jewellery purchases, which accounts for more than 40 per cent of the demand, is on the wane, with the galloping prices perhaps dampening the fervour.

The demand for jewellery is down from around 2,500 tonnes in 2003 to 1,908 tonnes in 2012. But investment demand for gold bars and coins has increased from 304 tonnes to 1,256 tonnes during this period. Similarly, the demand for gold from Exchange Traded Funds has doubled between 2004 and 2012.

What fuelled the rally?

With many of the emerging economies entering a growth phase from 2003, inflation too moved higher, making investors zero in on gold as a hedge. That the dollar was on a downward spiral in this period, with the dollar index losing 40 per cent of its value, also helped. The sharp increase in gold prices attracted investment funds in search of high-yielding assets, fuelling the price increase.

Another group that can stoke gold prices is the speculators (hedge funds, investment funds, trading companies and so on), which take a leveraged bet on prices through futures and options traded on exchanges. This market is many times the size of the gold spot market and can take prices above their intrinsic value in a vortex of buying. A classic example was the rise seen in crude oil prices in mid-2008.

One way to track the moves of the gold traders is through the positions they hold in the futures and options on exchanges. These positions surged from 2003 to a peak towards the end of 2011. But trading interest has been down by a third since then. This herd behaviour is typical among traders who chase assets that are rising and move out equally fast once they sense that the price has peaked.

Investment funds and fund managers out to make profits for their investors too lose interest in an asset that is declining or trending sideways. With international gold prices going sideways over the last two years, delivering 10 and 5 per cent return in 2011 and 2012 respectively, many investment managers are also parting with their gold holding.

The trigger for the current bout of sell-off was the news that Soros Fund Management LLC sold half of its holding in SPDR Gold Trust, a gold ETF, in the fourth quarter of 2012. Another big investor, Bacon’s Moore Capital Management, sold its entire holding in SPDR and reduced stake in other gold ETF products. Goldman Sachs slashed its forecast for gold prices in 2014 to $1,350 from the previous $1,490. Deutsche Bank, Barron’s, and Nouriel Roubini are some of the others who have announced that gold prices need to decline.

That gold is losing its lure for investors is also reflected in WGC data, which show that gold investment in bars, coins and exchange-traded products dropped 8.3 per cent to 424.7 tonnes in the fourth quarter of 2012 from a year earlier. For 2012, investments were down 9.8 per cent to 1,534.6 tonnes.

Not the end of the road

With speculators and investors in search of higher returns moving away from gold, does it mean that the prices are now going to continue falling? No, because there are many factors that are still supportive of gold prices.

Gold jewellery demand that was subdued due to higher prices can revive with the price decline. Inflation continues to be a concern in most emerging economies and depreciating value of fiat money will make many investors park at least part of their money in gold or gold-backed assets.

Central Banks will have to continue to increase their gold holdings in a bid to diversify their risk from a weak dollar and euro.

Strength of the dollar is ephemeral since the U.S. government has to resolve how to deal with the debt ceiling in the coming months. Expenditure cuts are likely to affect the nascent growth witnessed there. Sovereign debt troubles of euro-zone countries such as Italy, Greece, Spain and Cyprus are far from over and any trouble there will make risk aversion soar, sending money into gold.

These factors can save the gold prices from a deep decline. But prices could now readjust and settle in a new range, perhaps between $1,100 and $1,500.

But a steep rally taking the gold back to its peak is ruled out in the coming years.

(lokeshwarri.sk@thehindu.co.in)

More In: Lead | Opinion | Business | Markets

This is yet another of the ill-effects of the ongoing worldwide economic crisis. I firmly believe that our politicians should address the issues with greater professionality. Perhaps they should engage the services of specialists in the economic crisis, as some counties already do in the USA. For example, by engaging the services of the Orlando Bisegna Index, some US counties have resolved deficit problems and reduced unemployment. Although, I can't really see the point in hoarding gold; in a worst case scenario, it has no intrinsic value and you can't eat it!

from:  RickG
Posted on: Apr 21, 2013 at 23:37 IST

i am startled at ignorance in some commenters.. most don't realize
global fiat monetary system is at cusps of a massive collapse as every
thing is tied to dollar. Gold and silver are your only protection.. just
think why your milk rates are doubling fuel is exploding in prices almost
every thing is going up in price..its rather rupee is going down in
value, gold is just showing the degree of currency devaluation... its
not speculation like one guy is point out...

from:  shashi
Posted on: Apr 21, 2013 at 21:58 IST

Excellent article with supporting laws to protect the instinct of people
who want to hoard money in shape of yellow metal called Gold.

Sad no chance for collective growth of stakeholders of Gold except
hoarders and no jobs generation.

from:  Rakesh Manchanda
Posted on: Apr 21, 2013 at 11:44 IST

The price of gold rose because of speculators.Irrespective of whether the gold prices rise or
fall,there will be a base demand for gold for daughters' marriages,engagements,Dushera
Diwali and Gudiya's Padwa purchases .However the prices will depend more on speculative
purchases.Genuine guys wanting minimum gold for marriages and such other functions are
always cheated.The reading of the present situation says that Gold prices will fall still further
to about 15,000to18,000 per 10 grammes in the next couple of months.It is better to
postpone purchase till after Dushera.

from:  Ashok Prabhu
Posted on: Apr 21, 2013 at 07:51 IST

I am afraid that in this mad rush after gold due to decrease in prices
we will end up increasing the Current Account Deficit which govt and RBI
are trying hard to bring down.

from:  Kiran
Posted on: Apr 21, 2013 at 02:09 IST
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