When all else fails, investors flee to gold. The yellow metal, perceived to be the universal ‘store of value’, has seen unprecedented price levels following uncertainty in the global economy. Gold had touched an all-time high of $1,800/oz in the past week and although it has dwindled since, shedding $54 at the time of writing, the slight downtick seems meager compared to the trend that has been witnessed by all over the past few months. Hardly at the start of the year, Gold was trading at $1,400/oz and nearly three years ago, it was at $833/oz; dishing out a whopping annualised return of 37 per cent each year. Numbers in hindsight don’t lie: we are amid a gold rush. This is a similar kind like that which was witnessed in the late 1970’s. But is gold really the way forward or has the investment opportunity passed us? How much more is gold going to rise? These are the golden questions indeed.
Tangible safe haven
Wary of the debt crisis, weak global economic data, and S&P’s striping of the AAA rating held by the US for over 70 years, investors have turned to the yellow metal because they perceive it as a tangible safe haven compared to paper currencies, bonds and stocks. Following broad based equity sell-off and given that debt markets aren’t performing that well either, it was but natural for reallocation of portfolios towards gold. Data from the World Gold Council reveals that that both institutional as well as retain investors have contributed towards strong demand. However, the biggest individual holders of gold – central banks and governments – are believed to account for approximately 16.5 percent of the world’s gold. So far in 2011, emerging market central banks have ‘emerged’ as the biggest purchasers buying nearly 180 tons; over double the 73 tons purchased globally in the whole of 2010. China for one has seen substantial growth in gold investment, growing at 14 per cent annually since the deregulation of the local market there. A similar trend has been seen by the central banks of India, Russia, Indonesia, Thailand, and Korea. The appetite for gold from central banks in these economies is pointing to potential signs of waning faith in the west’s benchmark bonds and currencies and of changing motivations for accumulating foreign exchange reserves. Clearly, central banks do not regard the price level as too high and are diversifying their currency reserves in so that further accumulation does seem likely… or does it?
Many have questioned gold’s status as a perceived store of value. The traditional arguments presented are those concerning utility: fine it is used in Jewelry and has a small amount of industrial and technological use but is far from being a heavily demanded core resource for mankind. In itself, gold does not deliver any significant benefits for consumer. We agree, however, to view a debate in this regard as pointless. It is not rarity either that drives the price otherwise iradium and platinum would surely be more expensive. It is in fact the very perception of the word bullion is synonymous with wealth and has been so for countless eons. This belief is really what matters which, in our view, are the same set of faiths placed in currency notes as a medium of exchange. After all, what exactly are the words ‘In God we trust’ supposed to mean?
Giving some thought to the poor man’s metal – silver
An aspect which has not been highlighted enough is the position and trend observed in the sister metal – silver. At such high price levels of gold (translating to about Rs57,200/tola at current levels) surely some jewelry demand would have spilled over to the poor man’s metal; and so it has. It’s just that silver suffers the unfortunate fate of remaining in the shadows of its elder sibling. Currently trading at $39/oz, the commodity produced an outstanding annualised return of 97 per cent over a period of the last three years. This is after silver touched its all-time highs of over $47/oz earlier this year. With all the hullabaloo of gold, if ever there was a missed opportunity, it was that of silver. With the gold/silver price ratio hovering in the low 40’s, well below the historical range of 50-60, silver does seem overpriced for the moment and silver has already touched is peak for the short term.
The analyst’s golden forecast
Does the gold rush imply that gold is the safest investment around? No it’s not as safe as you may think it is. To feel secure of an investment in gold right now would not be of the ways of prudent analysis as clearly there is some degree of speculation in global gold trading. The Chicago Mercantile Exchange raising margin requirements and shifting from 29 to 1 leverage requirement to 23 to1 is indicative that some caution has emerged with respect to protection against speculative moves. We also believe that the recent slight tapering off of gold internationally was a result of profit-taking. Nevertheless, the tremendous amount of volatility seen with $50 range, movements occurring overnight place the metal in dangerous territory.
Having said this, some comfort can be derived from the fact that it is the central banks which have been leading the buyer frenzy. Such institutions are not expected to stop building their reserves, nor at least sell frantically, even if a bubble is formed. Given that the global economic situation does not seem to be any closer to recovery, talks of a double dip recession have emerged and with the absence of other attractive investment opportunities, gold seems to be the only beneficiary. It is therefore no surprise that large institutions such as Goldman Sachs and Bloomberg estimate gold to reach $2,000/oz by the end of the year. JP Morgan have gone a step further by indicating their expectations of the metal reaching $2,500/oz in the same period, though such levels seem unlikely. The Goldman Sachs estimate seems much more realistic.
Strategy: Following some expected retracement to $1,700/oz, BUY call issued as we believe suitable conditions remain intact to ensure that investment demand will maintain robustness in coming quarters.