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Monday, April 6, 2009

Gold Price - Where would it go? Why Should You Buy Gold Now?

For several years now, gold analysts have told investors pretty much the same thing. They said ‘buy gold’ when the price was Rs 7,700 per 10 gm in January 2006. They again said ‘buy gold’ when it touched Rs 9,200 in 2007, and then Rs 10,700 in January 2008. Last month, the price of gold touched an all-time high of Rs 15,700 per 10 gm and these analysts were still parroting the same advice.

It seems they will be proved correct once again. Gold is the only asset class that can hold out the assurance of value at a time when most other assets are being devalued by falling markets or inflation. This is the reason most analysts are bullish about the prospects of the yellow metal and expect prices to cross Rs 18,000 per 10 gm by the end of 2009.

This article is from Money Today authored by Babar Zaidi who spoke to a range of experts and came up with four reasons why you should consider investing in gold even at these stratospheric rates.

1. The global economy will remain in the doldrums
The world economy is in serious trouble and is likely to remain so in the coming months. The IMF has forecast that global growth in 2009 will be just 0.5%. This is the slowest growth recorded by the global economy since 1945 and far lower than the 2.2% estimated by the IMF in November 2008.

In these difficult times, gold becomes the automatic choice for investors who are searching for a safe option to park their money. “The global uncertainty and financial crisis don’t seem to be ending, which underpin gold’s role as a safe haven,” says Devendra Nevgi, CEO and CIO of Quantum Mutual Fund. True, investors are buying gold as if there is no tomorrow. Don’t go by the lack of retail interest in physical gold. The real action is in the commodity markets and ETFs.

The holdings of the world’s largest gold ETF, the US-based SPDR Gold Trust, ballooned to a record 1,029 tonnes on 19 February, up 250 tonnes or 32% in just 50 days in 2009. “If this trend continues, we could see a breakout in gold prices. The uptrend should continue till we see the financial crisis softening,” says Renisha Chainani, research analyst with Anagram Comtrade.

Will things improve in 2009? Unlikely. In India, the third quarter of 2008-9 was one of the weakest in recent times. But experts believe that there could be more aftershocks in the coming quarters. Also, the $700-billion bailout package announced by the US may not be enough. On 23 February, the Dow Jones dropped to a 12-year low. “If the global outlook continues to deteriorate, we could see a rally in gold. So maybe Rs 17,500 is possible much before year-end,” says an analyst with Kotak Commodities.

2. Dollar may depreciate against major currencies
The price of gold and the value of dollar have an inverse relationship. If the value of the dollar drops, more dollars would be required to buy the same amount of gold. So, the value of gold stays unchanged but the devaluation of the dollar pushes up its price. If the dollar declines against other currencies, it will also weaken against gold. This negative correlation may not be evident on a daily or weekly basis, but is almost always true over longer periods.

When the dollar was falling in the first half of 2008, gold was rising. But the abnormal market conditions over the past six-seven months have belied this principle. That’s because across the world a lot of dollardenominated debt is being purchased, increasing the demand for the dollar and pushing up its value against other currencies, even as gold prices have continued to climb. Experts say the current rise in the dollar is an aberration and it is ultimately expected to decline.

Also, some analysts fear that the US may resort to printing more money in the coming months to tide over the financial crisis. This would fuel inflation in the US and cause the dollar to slide. “Liquidity infusion by global central banks would create hyper-inflation in the next couple of years. Gold would emerge as an alternate currency for preserving wealth,” says Lakshmi Iyer, head, fixed income and product, Kotak Mahindra AMC

3. Crude prices could bounce back to $65 a barrel
Gold and crude oil prices move in tandem. At least that’s the general rule because high oil prices lead to high inflation, which in turn makes gold attractive as an investment. But we saw this correlation break down in the black swan year that was 2008. Crude oil prices touched an all-time high of $147 per barrel in July 2008, and then slipped, while gold continued its northward journey. The fall in crude prices was led by a huge drop in demand in the second half of 2008. Opec scaled down production, but the price fell to $30 in December 2008.

Crude prices are hovering around the $40 mark, but analysts expect them to rise in the coming months. “If the US government’s stimulus package works, global demand for crude will rise. Crude prices might touch $65 a barrel by the end of 2009,” says Naveen Mathur, head of commodities and currencies, Angel Broking.

That puts gold in a sweet spot. It will be a good hedge against deflation if the economy doesn’t improve. And it will be a good investment to counter inflation, if it does. Either way, gold’s value will go up. “We are very bullish on gold. By the end of 2009, Rs 17,500 doesn’t seem a very high price for gold,” says Mathur.

4. Global demand for gold would exceed supply
Adam Smith’s invisible hand will also push up gold prices in 2009. While the demand for gold is on the rise, gold mining companies have been cutting production for the past three years. The South African gold output declined by 14% last year, while the US production was down 2%. With a 3% growth, China was the leading producer in 2008. Also, the total gold sold by global central banks dropped by 42% to 279 tonnes in 2008. This has been the lowest level since 1996. These cutbacks on production and sales are gold-friendly and would enhance the value of gold.

But don’t buy right away. Experts expect a correction due to profit booking at higher levels. Others point to a certain seasonality in the long-term price trends. Gold prices tend to peak in March and then fall a bit before resuming the uptrend. So, buy just 10-15% of your planned purchase and wait for the correction.

Also, gold should not have an inordinately large allocation in your portfolio. As always, the principle of asset allocation should apply. While the exact figure depends on an individual’s financial profile, experts advise that you should allocate around 10-15% of your portfolio to the precious metal.
Source: Money Today

There is another thought to this, a contratrian view about Gold prices. Read it here. Gold - Has The Bubble Built? Will It Burst Soon?

Read more on Gold here.

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