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29 March 2024

Role as diversifying asset makes gold ideal

Gold prices rose by 25 per cent in 2009 compared to 2008. (AFP)

Published
By Sunil Kumar Singh

Gold prices have risen enormously in recent months with the precious metal keeping above $1,135 an ounce on Friday, edging lower from $1,157 the previous day. The gold price has been building steadily for nine consecutive years, ending last year 25 per cent higher compared to 2008, according to World Gold Council (WGC).

Gold has been bullish since the beginning of this year as well. According to an asset allocation report by Rothschild Private Banking & Trust e-mailed to Emirates Business, gold has held up well in the face of a raft of bad news recently. Although the dollar price has fallen slightly, in euro terms gold has remained well above €800 an ounce which is an indicator of its underlying strength.

So, what is keeping gold on top – is it just speculation or a fundamentals-driven bull run?

Safe haven story

Experts say gold becomes a natural safe haven during volatile times when investors are worried about the economic downturn and the weakness of paper currencies, especially the US dollar.

According to WGC, regression and correlation analysis suggest that there is no relationship between changes in the US GDP growth and changes in the gold price. Consequently, a US recession would not have negative implications for the gold price. This reflects the unique drivers of the gold price and underpins gold's role as a diversifying asset. So far, the brewing US recession has been positive for the gold price, as it has been accompanied by a rise in inflation and a falling dollar, which has boosted demand for gold as a dollar and inflation hedge.

However, apart from the dollar weaknesses, the most recent trigger pushing up gold has borne out of the concerns over sovereign debt issues such as in Greece and in some parts of euro zone that continue to drive investors towards gold as a relatively safer investment, say experts.

"We believe current prices of around $1,100 an ounce provide an attractive entry point for long-term investors. Gold remains a natural safe haven in times of turmoil and could see a surge in demand if debt problems in Greece – or other high-deficit economies – continue to escalate. The weak fundamentals underpinning most paper currencies should also support gold prices," says Dirk Wiedmann, Head of Investments, Rothschild Private Banking & Trust. Another factor making gold a lucrative investment asset is the uniqueness associated with it, say experts.

"Gold has no balance sheet. It has no earnings estimates. It is the only investment that is a true asset, which can neither be printed nor be created. This is the reason why many turned to gold during global recession. In fact during the times of recession or depression, gold is the only hedge against monetary deterioration, says Pradeep Unni, Senior Research Analyst/ Trader, Richcomm Global Services, Dubai.

What drives gold is its ability to store value or its appeal as a monetary asset. Across globe this is the only product that carries the same liquidity at all times at all places. Inflation, risk appetite, real yield on alternative assets, currency devaluation, geo-political tensions and financial chaos all lead to firmer gold prices. But conflicting developments in these multiple factors that drive the metal also turn it volatile and hence prices are never stable for gold, he adds.

Gold forever?

But analysts say despite the gold touching new highs recently, the possibilities of a gold bubble building up are far from being true.

"I don't think there is a gold bubble that is about to burst. Gold is certainly high at the moment and it may not be the best time to buy into gold, but given the uncertainties and volatility in the global economy I don't think gold would go down in value. And even if it does, it won't touch the level where it bursts," says Darren Ashley, Managing Director, Candour Consultancy, Dubai.

Gold looks set to continue its upward trajectory in years to come. It will not be a straight line with the risk of major corrections on the way like the one we experienced during 2008, says Ole Hansen, Senior Manager for CFD and Listed products, Saxo Bank.

He says among the strengths that are driving up gold prices are a few central banks turning net buyers of gold after years of selling and mining companies no longer forward selling their production. Further, inflation fear on the back of loose monetary policy among many OECD (Organisation for Economic Co-operation and Development) members is also fuelling up investment in gold. Investment flows into commodities, which have increased dramatically over the last year, and hedge against potential dollar depreciation are other fundamental factors driving up gold prices, he says expecting gold prices to touch $1350 an ounce in two years time.

On the other hand, a few experts remain bearish on gold. "We believe that gold is overvalued relative to its fundamentals," says Khurram Jafree, Director and Head of Investment Advisory Mena, Barclays Wealth.

Gold has been a very good investment during the financial crisis or during a period of a very loose monetary policy. Currently, gold is pricing in at the same level, as was the case in 1982 when there was Latin American debt crisis. Hence, gold prices could go higher in the short term before they end up falling in the medium and long term, he says.

There are two reasons why gold is priced at the present level, Jafree adds. One is the global economic downturn and the growing fiscal imbalances in developed countries, and the second is the launch of a number of ETFs (exchange-traded funds) that have been buying large quantities of gold. As per estimates, in the first quarter of last year, ETFs purchased the same quantity of gold as China purchased over the past six years, he says.

Experts say the high price level of gold has also turned investors to wait and watch for any possible correction in gold prices.

There is certainly an investment craze in bullion markets recently that has been entirely on the back of the global financial instability and associated risks of parking funds in other asset classes. However this isn't the right time to invest in bullions, as there is a greater downward potential for the metal in the coming months. Most investors are still in a wait-and-watch mode awaiting clearer trading signals to emerge before parking their investments, says Unni.

However, if an investor is buying gold purely for investment purposes with a time frame of about three to five years, price dip from here can be utilised to enter the markets, he adds. But the investor must have enough capital to hold on to the asset over the time frame to earn substantial rewards. Medium term and short trend based investors could wait for the fresh buying opportunities and should rather use leveraged investment options such as futures and options, he says.

An analysis of the data of the past 40 years – from 1970 to 2009 – hints that gold prices slide as markets inch towards the end of March. The initial three months of the year –January, February and March – have been always volatile with a gradual uptrend. Beyond that prices have been range bound with markets oscillating in extreme ranges, says Unni.

A closer look into the averages prices for the last 40 years also reveals that gold prices have been seasonally high in the months of October-November-December and in the early part of the New Year. In true sense, the ideal buying levels for long- term investment is usually seen towards the fag end of Q3 or early Q4.

Analysing the seasonal patterns on a time-to-time basis lowers the probability of succumbing to the temporary fluctuations in financial markets to keep the long-term market picture in focus, no matter how alluring the short-term moves become.

The question is, of course, whether there is a seismic shift in sentiment that could spell significantly more upside for gold or is it just another trap ahead of an impending correction that could provide another opportunity to enter the market. There is a clear possibility that as the global economies emerge out of credit-linked recession, central banks could be forced to raise the interest rates and this could drive gold prices lower, he says.

Gold terminologies

Gold certificates: Gold certificates are a method of holding gold without taking delivery. Issued by individual banks they confirm an individual's ownership while the bank holds the metal on the client's behalf.

The client thus saves on storage and personal security issues, and gains liquidity in terms of being able to sell portions of the holdings (if need be) by simply telephoning the custodian.

Fineness: Gold purity, usually expressed in parts per thousand. Thus 995 or two nines five is 995/1000 or 99.5 per cent pure. 995 was the highest purity to which gold could be manufactured when good delivery (qv) was determined, but for very high technology applications now it is possible to produce metal of up to 99.9999 per cent purity.

Karat: Unit of fineness, scaled from one to 24. 24 karat gold (or pure gold) has at least 999 parts pure gold per thousand. 18-karat has 750 parts pure gold and 250 parts alloy, etc.

Spot price: The price for spot delivery which in the gold market is two days from the trade date.

Troy ounce: The standard weight in which gold is quoted in the international market, weighing 31.1035g. Named after the old French city of Troyes, where there was an annual trading fair in mediaeval days and where this was a unit of weight.

Source: World Gold Council