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Why investors MUST book partial profits in gold

April 27, 2020 10:07 IST

Such an economic environment tends to be positive for gold, the ultimate safe-haven asset. Since gold cannot be debased by central banks, it naturally gains in value.

Gold

Illustration: Dominic Xavier/Rediff.com

Gold exchange-traded funds (ETFs) have given investors an average return of 48.7 per cent over the past year.

Investors who have become overweight on the yellow metal (vis-à-vis their original allocation of 10 or 15 per cent of their portfolio) should book partial profits from time to time and bring their allocation back to the original level.

 

If they allow themselves to become heavily overweight on the yellow metal, it will increase their portfolio risk.

Whenever the bull-run in gold ends, their portfolio could take a beating.

Most experts today are of the view that the rally in gold is likely to continue.

“World gross domestic product growth, according to the International Monetary Fund, will fall to minus 3 per cent, and it may not rebound quickly,” says Chirag Mehta, senior fund manager-alternative investments, Quantum Mutual Fund.

Such an economic environment tends to be positive for gold, the ultimate safe-haven asset.

Moreover, central banks have cut interest rates and may reduce them even further in future.

Real interest rates across the globe are low or negative.

Usually, there exists a negative correlation between gold and real interest rates.

By making bonds less attractive to hold, low real interest rates support the price of gold.

A lot of demand destruction has occurred in economies across the globe.

Governments are expected to support both families and businesses and thereby prevent demand from collapsing.

“Governments will issue treasury bills and central banks will purchase them.

"Expanding government fiscal deficits and printing of money by central banks will cause currency depreciation, which will, in turn, support the price of gold,” says Kishore Narne, associate director and head of commodities and currency, Motilal Oswal Financial Services.

Moreover, most of the liquidity that central banks pumped in during the last crisis did not get unwound.

Now that another crisis has hit, more money is being printed.

This is expected to result in the permanent debasement of currencies.

In such an environment, an asset like gold, which cannot be debased by central banks, gains in value.

The US dollar is strengthening currently, but this trend may not last.

“Due to the deficit and debt that the US is incurring today, the dollar may not remain strong for long,” says Mehta.

Moreover, in an environment where equities, debt, and real estate are unlikely to perform, gold may also benefit from the TINA (there is no alternative) factor.

A few factors could slow down gold’s rally, though they are unlikely to alter its direction.

“Central banks bought 658 tonnes of gold in 2019 - the second-highest in the past 50 years.

"This year onwards, many central banks may sell some of their gold holdings to support their economies.

"This could slow down the pace of the rally,” says Narne.

If the panic caused by the pandemic abates, that too could cause the rally to slow down.

“The pandemic is peaking in a lot of countries, and they are now slowly opening up again for business.

"Hence, gold prices may not rise in the same manner as earlier,” says Ketan Kothari, director, Augmont, a gold refiner and bullion producer.

According to him, a lot of people may also sell gold at the current high levels to meet their other financial needs.

After gold’s recent high of Rs 47,327 per 10 grams on the MCX, some profit booking appears likely.

“A correction of 8-10 per cent from the recent all-time high would be a good level for new investors to put money in the yellow metal,” says Rupak De, senior research analyst, IIFL Securities.

New investors should use corrections in the yellow metal to build allocation over the next six to 12 months.

Sanjay Kumar Singh
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