Thursday, 13 August 2015

Is Gold still a safe Bet ?



All that that glitters is not gold

Gold has dipped below Rs 25,000 per 10 grams, to trade at a five year low and many investors wonder if the yellow metal has lost its glitter and should it be a part of the investment portfolio?
Gold has failed to sparkle for investment portfolios and the most reliable hedge against risk and inflation has not worked well in the last few months.

Investments in gold has come a big disappointment of late and during a period in which the overall world economic situation having lack of overall macroeconomic stability and fear of default by a number of countries and the stock market crash in the largest Asian market would normally push the price of gold up but the big question to answer is that is gold losing its traditional role in a diversified investment portfolio.

In the last few years gold an as investment option on a portfolio level has been very disappointing as it has not performed its traditional role as a good hedge to risk and inflation during critical periods by performing well during risk off periods where other equity markets have performed very badly.  

It did not participate in the surge upwards in nearly all financial asset prices; and it has not provided protection in the more recent downturn in risk markets. Throughout this period, gold has not benefited from rock-bottom interest rates that compensated for one of its main disadvantages as a financial holding — namely, that gold holders do not earn any interest or dividend payments. It has also shown an unusual lack of sensitivity to multiple geopolitical shocks, Greek-related concerns about the single European currency, and the vast injection of liquidity by central banks and the problems faced by the largest Asian economy.

The performance of gold has been so dreary that a number of professional investors and hedge funds have bet against the asset there by adding further pressure and resulting in the price to decline almost 18% in the past 12 months, owing to the technical weakness on the charts.

This historical anomaly could be attributed to several reasons and cyclical factors have played a role but the main factors for this are more structural in nature.    

·      With the explosion of equity exchange traded funds globally to the deepening of interest and availability of sophisticated credit products investors have found more direct ways to express their views about the future, particularly in a world in which central banks have had such an important influence on asset prices.

·      With lack of meaningful inflationary pressure along with the general decline in interest in commodities among institutional investors due to slower global growth gold has become a lot less attractive to investors.

·      Gold faces the growing risk of lower demand from central banks, once deemed reliable core holders, part of this is driven by the fall in holdings of international reserves by the emerging world, particularly as they try to cope with the impact of lower commodity prices.

·      The historical correlation have broken down, the analytical case for investing in gold has been increasingly challenged at an overall portfolio level there by resulting in the overall lack of demand and putting pressure on the price.
·      Due to the lower prices of gold there has been an increase demand in physical use of gold in form of jewelry and ornaments but this demand is too small to offset the erosion of investor at an overall all demand supply level.

  
Assessing the cyclical versus secular/structural balance of these factors, it is hard not to conclude that gold may well be experiencing an erosion in its positioning as a core holding in diversified institutional and retail investment portfolios. The more this happens, the more enticing it will be for fast money to short the metal as a way of inducing even greater sales by disappointed core holders.

This situation is unlikely to change soon but it need not be terminal. A shift would probably require a broader normalization of financial markets, including a diminution in the direct and indirect role of central banks in determining asset prices and their correlations. Until that happens, the glittering metal is likely to continue to languish.


-Farzan Ghadially

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