In the midst of the equity euphoria in last few months, investors appear to have forgotten that gold has fallen sharply. Consider these numbers! In August 2020, global gold prices had touched a life time peak of $2,063/oz and from that point it has fallen 14%. There appears to be some eerie coincidence about the second half for gold.
In September 2011, in the aftermath of Lehman implosion, gold touched a life-time high of $1850/oz. However, from that point, gold corrected sharply to $1050/oz by early 2016. The one-year chart of gold captures the gist of the gold price movement.
Look at any asset return chart in 2019 or 2020; and gold was the top performer. Gold rallied over 50% in less than 3 months between June and August 2020 when the pandemic was at its peak. Why has gold suddenly started giving up gains and losing shine? Gold may not exactly have lost its allure, but here is why gold prices have fallen.
Gold has always been an inverse dollar-trade
The Bloomberg dollar index (DXY) has shown signs of bottoming out around 89 levels and has bounced back sharply. The DXY may still be an understatement because the dollar has appreciated sharply against most global currencies barring the UK Pound and Chinese Yuan. If these two currencies were excluded, US Dollar was actually stronger. But it is more about expectations of dollar strength.
There are 3 factors expected to spur the US dollar higher. Firstly, high frequency indicators have been hinting at a return to growth, which is favourable for equities. Secondly, the 10-year benchmark bond yields have rallied from 0.68% to 1.38% in the US. That has added to the opportunity cost of holding gold. Lastly, there are expectations of rate hikes by the Fed. Powell may talk dovish but the CME-FEDWATCH is showing signals of 3-4 rate hikes in 18 months. That will strengthen the dollar further. Once the US government clears the $1.9 trillion stimulus programme, it will be growth accretive.
With stability comes an appetite for risks
The situation was summed up by P R Somasundaram, Managing Director of the World Gold Council, “Stock markets gained on bullish economic outlook. The market seems to have an appetite to pick up riskier assets now”. It is hard to fundamentally explain equities at such steep valuations, but abundant liquidity by central banks is driving asset prices higher. Valuations are a matter of perception but liquidity is real and nobody argues with liquidity.
In the last two years, there were sufficient reason for investors to flock to safe haven assets. The US and China were engaged in a prolonged trade war impacting world trade. Trump was not making life easier in the Middle East and Iran was adding to problems in the Straits of Hormuz. COVID created a new event risk and most economies saw 2-3 consecutive quarters of negative growth. All these uncertainties fed the appetite for gold as a safe haven in uncertain times. However, since the Sep-20 quarter, sentiments have drastically changed and the change of guard in the US has opened the doors for greater risk taking by investors.
How gold prices were impacted in India?
Gold prices in India are largely a function of global gold prices, which forms the benchmark for local pricing. Unlike global gold, which is priced in dollars/troy-ounce, the Indian gold is priced at Rs/10-grams. The chart below captures the India gold price over last 1 year.
While global gold prices fell 14% from their peak levels, the Indian gold prices have fallen nearly 18% from their peak. There are two key reasons for this difference.
Has gold lost its allure?
The finance minister in Union Budget 2021 effected a cut in customs duty from 12% to 7.5%. That reduced the landed cost of gold and thus the domestic price of gold also fell in tandem.
The second factor is the INR/Dollar equation. In last 1 year, the INR has appreciated against the dollar due to strong capital flows and that helped lower gold prices in rupee terms, more than in dollar terms.
It would be naïve to believe that a metal that sustained human interest for 2500 years would suddenly lose allure. The fall is due to a mix of greater certainty in the global economy as well as the emergence of new-fangled crypto currencies as alternatives to gold. However, gold has proved itself as a safe haven, a hedge against inflation and a preserver of value for more than two millennia. That is not going to be so easy to unsettle.
Euphoria over equities and risk assets is one side of the story. Things could change if the Fed starts to taper and markets get jittery. The world will, perhaps, always need a physically reliable back-up asset class. That is what gold has been all about. In short, the role of gold as an asset class in your portfolio allocation continues.