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Why gold is likely to retain glitter

August 18, 2014 11:09 IST

Why gold is likely to retain glitter

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Chirag Mehta

If it were not for geopolitical worries, gold probably would have been lower than its current levels.

After the big sell-off in gold last year, its price has been consolidating in a range, with pivots at around the $1,300 an ounce levels (around Rs 28,000–29,000 for 10gm in Indian terms).

A mix of opposing factors seems to be resulting in a range-bound market.

Demand from physical/bargain buyers is serving as a strong floor and geopolitical tensions in Ukraine and around West Asia have helped gold stage a comeback.

Whereas, the US Fed tapering, coupled with the advancement of expectations on rate increases, have been a worry for gold markets.

Tapering to a larger extent already seems priced in.

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Image: A sales assistant puts back a gold Buddha-shaped pendant after showing to a customer at Caibai Ornaments store in Beijing.
Photographs: Petar Kujundzic/Reuters

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Why gold is likely to retain glitter

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On rate increases, the markets have been running ahead of expectations.

Rate increases by the Fed would require a really strong economy or high inflation.

The economic data remains a mixed bag at best and there are no clear signs of sustainable high growth with a labour market glut showing no signs of abating.

If the Fed were to increase interest rates on inflation fears, this in itself would be positive for gold.

Also, in contradiction to common belief, interest rates need to rise much higher before they become really attractive to investors and distract money from gold.

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Image: A gold jewellery shop owner arranges ornaments at a counter in Kolkata.
Photographs: Parth Sanyal/Reuters
Tags: Fed

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Equities, especially the US markets, appear expensive to many investors and therefore makes these ripe for a correction.

A set of strong economic numbers might be enough to force the US central bank to turn more hawkish acting as a trigger for correction.

However, the markets can remain irrational for longer than we anticipate, which could pose as a risk in the short term.

If the Fed fails to sound hawkish, the combination of stronger growth and build-up of liquidity over the years could spark inflationary fears.

Either of the factors could drive investors to gold.

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Image: A set of strong economic numbers might be enough to force the US central bank to turn more hawkish acting as a trigger for correction.
Photographs: Reuters
Tags: US , Fed

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Why gold is likely to retain glitter

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However, investors seem to be waiting for a clearer, firmer sign that gold prices have, in fact, bottomed out.

If it were not for geopolitical worries, gold probably would have been lower than its current levels.

The risks inherent in the international political log-jam appear only partly figured into a risk premium in gold with the longer-term implications of these hostilities still don’t seem fully factored in.

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Image: The risks inherent in the international political log-jam appear only partly figured into a risk premium in gold with the longer-term implications of these hostilities still don't seem fully factored in.
Photographs: Reuters
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The reality is that there has been a major reduction in inter-governmental co-operation. This will propel more investors to seek gold as a portfolio diversifier over the next several years than otherwise would be the case.

The crisis in West Asia and the Russian intrusion of Ukraine could potentially escalate, leading to a jump in gold prices.

Until then, gold prices are likely to consolidate in the near future.

Given the policy mind-set, it would not be surprising to see further unconventional policy response on any signs of unsettling of asset markets; this will act as a likely upward trigger for gold prices. 

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Image: The crisis in West Asia and the Russian intrusion of Ukraine could potentially escalate, leading to a jump in gold prices.
Photographs: Reuters

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In the Indian markets, along with the international gold prices, the rupee rate and government taxes also play an important role in determining gold prices.

The rupee has largely been trading in the 60-62 range and appears to be closer to fair valuation.

Regarding levies, markets were hoping for some relaxation in the Budget, which did not happen nor seems likely in the near future.

With the pick-up in demand as the festive and marriage season approaches, there can be some premium that gets built into the price as imports remain constrained.

Chirag Mehta is fund manager-commodities, Quantum AMC


Image: In the Indian markets, along with the international gold prices, the rupee rate and government taxes also play an important role in determining gold prices.
Photographs: Reuters

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