The price of precious yellow metal has plunged by good -18.9% from their last peak of U.S. $ 1,895 (attained on September 5, 2011) and thus thrown upon a big question in the mind of several investors, which is - “Is gold, really a safe haven?"
Reason for this corrective phase
As the Euro zone debt crisis continued to send shivers to the global economy on account of their lapse in putting public finances in place, the recent intermediate positive news on Markit's Eurozone Composite Purchasing Managers' Index (PMI) registering an uptick for the second consecutive month to 47.9 in December 2011 (from 47.0 in the earlier month), have led to prices of the precious yellow metal to soften.
So, is the Euro zone out of the woods?
But it is vital to recognise that the Euro zone is not out of the woods. It is noteworthy that the Markit's Eurozone Composite Purchasing Managers' Index (PMI) measures the activity of thousands of Euro zone companies, has improved of course, but the Euro zone is struggling badly with sovereign debt crisis. Barring U.K., Germany and France who still enjoy the prime ‘AAA’ rating, other nations - especially the PIIGS (Portugal, Ireland, Italy, Greece and Spain) in the Euro Zone have experienced a downward revision in their sovereign ratings from rating agencies due to their situation of a debt-overhang. Moreover, the recent European Union (EU) Summit too has not contributed in assuaging the negative market sentiments and therefore financial turbulence still persist across both - developed and emerging market economies. In the EU summit while the European leaders did agree on a new fiscal compact, involving stronger coordination of economic policies to strengthen fiscal discipline, the medium and long-term sustainability of the Euro zone to resolve the short-term funding pressures is still questioned by markets. Q3 growth (of 0.8%) in the Euro zone is still anaemic and 2012 growth, is now expected to be weaker than earlier projected. And interestingly reflecting these projections, the European Commercial Bank (ECB) has cut its policy rates twice in the last two months, and has also implemented some non-standard measures.
Even the world’s largest economy not spared!
Speaking about the U.S., they too have lost their prime ‘AAA’ rating which they enjoyed for a long time. The burgeoning debt- to-GDP ratio for the U.S. at 97.5%, due to the increase in the debt ceiling limit to U.S. $16.4 trillion has brought down their ratings to ‘AA+’ (with a negative outlook). While at present they have recorded a better Q3 economic growth rate (of 2.0%), as compared to the immediate last quarter, the overall trend still appears substantially below trend.
Heaping up gold
(Source: World Gold Council, PersonalFN Research)
The chart above also reveals that being aware of the fact that turbulence in the global economy still persists, the most economies led by the U.S. and the Euro zone ones are maintaining elevated levels of gold reserves too, in order to hedge the risk of an economic breakdown.
Worrisome economic factors in the domestic economy
In India too while the WPI inflation for November 2011 (data released on December 14, 2011) has mellowed to a 12-month low of 9.11% mainly due to softening in food inflation (4.35% for the week ended December 3, 2011), the stubbornness in WPI inflation is still evident at it continue to be over the 9.00% mark for 12 consecutive months, and is also above the 6.00% - 7.00% comfort range of the central bank. Moreover, the country’s economic growth rate has also dwindled since last Q2FY11, and even Q2FY12 growth is isn’t encouraging, as it has dropped to a low of 6.9%.
The slippage in the growth of Q3FY12 advance taxes payment (to 10.0%), made by top 100 companies also reflects a dent caused to the Indian economy and to corporate India’s profitability led by factor such as high borrowing cost, high input cost and a high interest rate regime, due to anti-inflationary monetary policy stance maintained by the RBI in the past. Even though at present RBI has taken a pause in its policy rates and tried to be accommodative given a gloomy global economic outlook, we believe it may not provide relief to corporate India because borrowing cost and input cost still remain high. Also with the Government experiencing policy paralysis, reforms are driven on a slow track which again is holding back corporate India from growth, thus also leading to situation where the 4.6% fiscal deficit target set by the Government may not be met.
What should investors do?
Primarily we believe that gold is still a safe haven. While many of you would disagree with us you or would be jittery to invest in gold at these elevated prices of gold, you need to recognise the fact that, with the global economy being on an edge with a debt-overhang situation in the Euro zone, the risk of a contagion spreading still remains. Moreover, if inflationary pressures remain in India, as seen at present this in turn may lead to gold continuing its northward journey, as smart investors would prefer to take refuge under the precious yellow metal, thus hedging themselves against prices. Of course sideways movement is likely, if some intermediate positive news is disseminated by the global economy, but the secular trend still looks intact.
As an asset class, gold over the years as depicted by the chart below has shown a secular uptrend. On January 1, 1979 the price of gold was about U.S. $ 226, and today (i.e. as on December 16, 2011) despite a series of corrective and consolidation phases, gold has become bolder and has reported whopping returns of +605.3% (on absolute basis).
Data as on December 16, 2011
(Source: World Gold Council, PersonalFN Research)
Also one should not rule out gold for its worthiness poised by the following three main reason reasons:
- It is a hedge against inflation
- It adds stability to the investment portfolio
- Asset Allocation avenue
We believe that one should use corrective and consolidation phases in prices of gold to buy more, thus safeguarding against contingent events of the future, since the precious yellow metal will always shine during economic uncertainties. At PersonalFN, we recommend that you should have a minimum of 5%-10% allocation to gold, and invest in it with a long term perspective with a time horizon of 10 to 20 years.