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Gold may go up, but use it to diversify

Gold prices in Indian markets touched an all-time high of Rs. 32,300 per 10g on the Multi Commodity Exchange (MCX) on September 6. On the contrary, in international markets, gold has posted a marginal gain since the beginning of the calendar, Rajesh Kumar reports. For a safe future

business Updated: Sep 08, 2012 01:47 IST
Rajesh Kumar

Gold prices in Indian markets touched an all-time high of Rs. 32,300 per 10g on the Multi Commodity Exchange (MCX) on September 6.

On the contrary, in international markets, gold has posted a marginal gain since the beginning of the calendar.

In the international market, gold, after touching the level of $1,900 (Rs. 1.05 lakh) per ounce in September 2011, corrected to test levels under $1,600 per ounce and remained at those levels from May to July but gained about $100 just in the month of August.

Indian markets did not see similar correction in gold prices as the rupee weakened against the dollar and gold being a dollar-denominated commodity, kept its rupee price firm.

Market expectation

Gold prices have moved up in the last few days on the expectation of another round of quantitative easing from the Federal Reserve in the US.



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Quantitative easing happens when the central bank buys assets, primarily bonds, from the market in order to inject money into the system.

The expectation in the market was revived after the minutes of the Federal Open Market Committee (FOMC) meetings held on July 31 and August 1 were released recently.

It said: “Many members judged that additional monetary accommodation would likely be warranted fairly soon unless incoming information pointed to a substantial and sustainable strengthening in the pace of the economic recovery.”

But, in the much anticipated speech at Jackson Hole on August 31, Ben Bernanke, the chairman of the Federal Reserve did not promise anything exclusively on further easing of the monetary policy, but underlined that “the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labour market conditions in a context of price stability”.

The market is hoping to see a positive outcome from the FOMC meeting scheduled for September 12-13.

Demand trend and price movement

Gold has traditionally been regarded as a safe haven and a hedge against uncertainty, but that definition may be changing now.

In the last one year, when there was so much uncertainty in the global financial market, gold prices remained more or less stable, which is also reflected by the demand for the yellow metal.

In the June quarter, the total global demand for gold was down 7% with major markets such as India and China showing decline in demand.

“At the moment, gold has moved out of the territory of being the safe haven.,” said Naveen Mathur, associate director (commodities and currencies), Angel Broking Ltd. Mathur explains that it is being driven more by sentiments and a negative correlation with dollar is also playing out.

Put differently, if the dollar remains firm against other currencies, gold prices will remain softer, but any easing from the central bank in the US will weaken the dollar and that will result in higher gold prices.

During the last round of quantitative easing by the Federal Reserve, which was announced in August 2010 and ended in the second quarter of 2011, gold rallied from the level of $1,180 per ounce to $1,500 by the end of June 2011, a gain of about 27%.

As of now, there is no clarity on quantitative easing by the Federal Reserve, and prices will depend on a variety of factors other than the size and tenor of easing, if any.

How the situation pans out in Europe will also be equally important.

Any easing by the European Central Bank will help (though it has hit a roadblock for now).

Meanwhile, Indian buyers should be careful of the currency movement. In case of further easing by the Federal Reserve, more dollars will flow into the Indian market as portfolio and direct investment, which may push the Indian rupee against the dollar and reduce gains to that extent.

What should you do?

Gold price movements are generally speculative as it has no intrinsic value.

It does not pay you interest like bonds do and it does not give dividends like shares do. Also, there is no tool to judge if the prices are overvalued or undervalued.

So should you be buying after gold has crossed another psychological level in the Indian market?

“Gold should be used as a diversifier and hedge against central bank easing which can result in higher inflation and investors should have gold in their portfolio,” said Lakshmi Iyer, head of products and fixed income, Kotak Asset Management Co. Ltd.

Though some experts argue that one should keep about 10-15% of their portfolio in gold, there is no scientific reason for that and one should keep the exposure according to one’s own comfort level.

However, it is also important to underline that one should not depend on the expected price rise in gold and make it a primary investment.

The outlook looks positive for gold, but price movements are not always unidirectional and there could be a correction which is sustained for a long period.

Therefore, as experts argue, gold should be used as a tool to diversify your portfolio and should not form the primary asset class.