The Hindu Business Line : The gold rush

Gold price has been increasing for the past two decades and may touch the $1000 (an ounce)-mark anytime. Gold and dollar are closely related but move in opposite directions. When the dollar weakens, investors take to gold as a sound alternative, says S. SRINATH.

Strengthening of the rupee against the dollar has raised the demand for the yellow metal.

With the looming uncertainty in the stock markets, gold as a medium of investment and as a cushion for security is gaining in importance. The prevailing price levels of gold reflect investor concern about the turbulence in the world economy and the global political tensions. Gold price has been increasing for the past two decades and may touch the $1000 (an ounce)-mark anytime. Gold and dollar are closely related but move in opposite directions. When the dollar weake ns, investors take to gold as a sound alternative. The Federal Reserve’s cuts in interest rates to minimise downside risks to growth has not helped the matter.

Little options

The volatile political situation in our nuclear armed neighbour; the predicted dip of the US economy into a recessionary mode; Iran/North Korea nuclear programmes; the unilateral declaration of independence by Kosovo and Russia’s reaction to it; the talk of the French taking military action if Iran goes ahead with its nuclear programme; the saga of sub-prime lending and the financial crunch it brought with it; and the tumbling dollar, leave the investor with little options to chose from the portfolio basket. This is in addition to crude oil breaching the $100 levels. The global food prices are soaring, triggering inflation and the UN is reportedly seeking additional $500 million to finance its food programme due to high prices.

Indian investors are already showing a tepid reaction to IPOs. At the global level, inflation has crossed double-digits in Qatar and UAE with China reporting above 6 per cent.

A similar situation occurred in 1979 when gold touched $850 an ounce with the US economy reeling under a double-digit inflation, Iran seeing the last days of monarchy and the Soviets flexing their muscles in Afghanistan.

As an inflation hedge

Now, the sub-prime crisis and the inability of the West, be it bankers or political leaders, to provide a firm solution to this banking crisis strengthens the claim of gold to be playing a significant role as an inflation hedge. It is reported that losses on securities linked to the US sub-prime mortgages could reach $400 billion. Donald Luskin of Trend Macrolytics, a California-based consulting firm that caters to institutional investors, says that “Gold is one of the best forward looking market-based indicators of inflation”.

To insulate their economies against the dipping dollar, the Asians, the Russians and other petro dollar countries diverted their reserves into euros boosting the capital inflow into the Euro Zone to €200 billion during the first half of 2007, as per BNP Paribas. With reports of the sub-prime plague reaching Germany, emerging economies are now turning to gold as shelter.

In the light of these developments, it is interesting to note that the Russian President, Mr Vladimir Putin, has advised the Russian central bank to increase the gold portion of its $470 billion reserve to about 10 per cent. The newly-emerging Asian economies and the petro dollar states are sitting on reserves of about $6.6 trillion. A small shift in their portfolio to gold would push the prices.

Volatility and demand for gold

On a micro level, the introduction of exchange traded funds that would enable small investors to invest in gold funds has increased the demand for gold. It is reported the holdings of such exchange traded gold funds hover around 800-900 tonnes, surpassing the holdings of many central banks. These funds enable investors to invest without the hassle of holding on to the physical commodity.

India is the largest market for gold in the world. The weakening of the dollar has not left India unaffected. The strengthening of the rupee against the dollar has raised the demand for the yellow metal by as much as 72 per cent during the first half of 2007. According to the World Gold Council, India’s demand reached an all-time high of 317 tonnes in 2007.

However, with volatility in gold reaching its peak, Indian demand for gold slumped during the fourth quarter of 2007 by almost 64 per cent, while China’s demand has increased in the fourth quarter.

World Gold Council has stated that consumers in India are waiting for the gold price to stabilise; demand has further slumped to 5 tonnes in January 2008, when compared to 62 tonnes in the corresponding previous period.

Out of the total gold processed in India, only 15 per cent comes from recycled gold indicating that there will be demand for imports once the price stabilises.

Similarly, the demand for gold from West Asia is also on the rise. China has now replaced the US as the second largest buyer of gold after India. The overall demand for gold was 4 per cent higher in 2007 and stood at 3,547 tonnes.

Concerns on supply

While the demand for gold is increasing from all quarters — governments, banks, exchange traded funds or private investors — the supply side is becoming weaker.

The mines in Africa are reporting low yields and those in Canada are reported to have passed their peak production. Costs are also increasing and affect the pricing of the metal. These indicate that the supply rate will diminish until further discoveries are made.

Again, power shutdowns in South Africa are adding to anxiety on supply . But, then, gold is a unique commodity in that more than 90 per cent of that mined so far is deemed to be still in existence whether it is bullion or jewellery.

It is not consumed in usage and the loss of 10 per cent due to industrial processing is capable of being recycled as it pays to recover and reuse. According to GFMS, precious metals consultants, China has also become the world’s largest producer of gold ending 102 years of reign of South Africa.

According to John Reade, the precious metals Chief at UBS, “The feeling is that there is a lot of money around and not much gold.”

Carlos Sanchez, a precious metals analyst at CPM Group, expects gold prices trending upwards throughout 2008. This is against an annual global growth of about 15 per cent money supply. But analysts feel that even $1,000 an ounce is equivalent to $400 in real terms, if one takes 1980 as the base year. In real terms, to reach $1,000 an ounce, the price has to rise to $2,500 which may take a while.

BMO analysis

The market now is so volatile that forecast by the US-based financial service provider, BMO, in October, 2007, pegging price at $800 per ounce while raising the long-term forecasts to $600 may need revision.

The forecast was based taking into account the fact that in 2007, gold outperformed major stock markets, broad-base metal price indices, currencies and bonds. BMO analysis includes the possibility of euro being devalued to protect trade balances with China and other emerging economies, the rising production costs of gold and the rising middle-class income in China and India.

Gold and real estate

And, finally, it will be interesting to note that in Vietnam, real-estate values are equated on their value in gold and with the surging gold price, several people have cancelled their bid to buy houses.

The precious metals market is so volatile that silver too reached its peak in 27 years bringing a fall in the gold/silver ratio. This would leave options open for silver/gold cross trade.

Is gold becoming a significant factor in the current turbulent global economic situation? “Stocks are down and bonds are yielding next to nothing — so what’s not to love about gold” — David Berman

(The author is a Chennai-based chartered accountant.)

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