Is the rally in gold coming to an end?

Over the last few days I have become even more convinced that the upcycle in gold is coming to an end now and we will see a significant correction.

I have talked to a variety of investment advisors/ fund managers/ investors in general. The only commodity that everyone recommended a ‘buy' on was gold. It has become the most over-owned and over-sold asset — in terms of being sold as an investment idea.

Data coming out of Indian mutual funds is also reflective of the sentiment. Inflows into gold funds have been higher than that into equity funds over the last six months. This is despite the fact that the total assets under equity funds are more than 20-30 times that of gold funds.

Likely to stay at top

India has traditionally been the biggest consumer of gold in the world. This is not likely to change despite there being talk of China becoming the biggest consumer. The traditional jewellery demand in India is not a fad or fashion but something that is engrained in the Indian system. This is very different from buying into an asset class that is fancied and where the prices are continuously going up.

The significant increase in gold prices over the last few months have bought physical gold demand in India to a virtual standstill. According to the data coming out of the World Gold Council Gold demand in the third quarter of 2011 reached 1,053.9 tonnes, an increase of six per cent compared to the same period last year. This equates to $57.7 billion, an all-time high in value terms.

According to the World Gold Council's Gold Demand Trends report for Q3 2011 this increase was driven by investment demand which rose by 33 per cent year-on-year to 468.1 tonnes.

The demand for physical demand for the traditional purposes fell by 15 per cent in this quarter. Gold supply was 1,034.4 tonnes in the third quarter of 2011

Q3 demand dips

Overall, Indian jewellery demand in Q3 saw a 26 per cent decline in tonnage, when compared to the same quarter in 2010, to 125.3 tonnes.

The question then is, for how long can investment demand hold up the price of a commodity in light of falling end-user demand.

The most drastic example of this was the way in which oil prices fell in the year 2008 from levels of $150 to $30 in a period of just six months.

That is not to say that such a thing is likely in the case of gold. However, the truth of the matter also is that lot of investment demand is trend-following demand and also exists because of the fear psychosis that prevails globally today.

Investment advisors and asset allocators find it easy to sell Gold ETF's to investors who are running scared of investing elsewhere.

In a number of European countries investors are reluctant to put deposits in the banks of their own countries.

Similarly, given the way global equity markets have performed and the kind of volatility that we have seen investors are unwilling to allocate much to equities at this stage.

Clear view required

As a result, deposits of banks perceived to be safe and bonds from Germany, UK and the US have become safe haven investment plays.

Besides this, gold is perceived to be the reservoir of value (and not without reason). However, investors investing into gold need to be clear of their expectations from this asset class.

The probability that gold will yield much below what investors can earn via fixed deposits of banks in a country such as India where five-year deposits of the safest of banks yield near 10 per cent is extremely high at this stage.

As gold prices start to first stagnate and then fall, there will not only be low incremental flows into gold-linked investment products.

There could even be outflows. A large number of hedge funds that have built up significant long positions in gold might also go short as the trend reverses.

If gold prices start to first stagnate and then fall, there will be low incremental flows into gold-linked investment products. There could even be outflows. A large number of hedge funds that have built up significant long positions in gold might also go short as the trend reverses.

The author is CEO — PMS, Prabhudas Lilladher Group. Views expressed are personal. 

Source: http://www.thehindubusinessline.com/features/investment-world/article2723821.ece?ref=wl_features