Many Indians believe that gold is an asset class whose value never depreciates for long. Many of you who do not track international gold prices would be surprised to know that they have fallen nearly 35% from their all-time high made in September 2011. Indian investors didn't witness such a deep fall in gold prices. During this period, Indian rupee too depreciated almost equal in amount. Since gold is dollar denominated in the international market and India is one the major importers of gold, gold prices in India remained relatively unaffected.
 

Is gold losing sheen?

NAV Data as on December 19, 2013
(Source: ACE MF, PersonalFN research)  

As you might be aware, gold and US dollar share negative correlation; i.e. they move in opposite direction. Therefore, to understand the direction of gold prices, we must know the direction in which U.S. dollar may move. Now that Federal Reserves (Fed) in the U.S. has announced that it will reduce its bond buying by USD 10 billion early next year. Reduction in monetary stimulus means higher value of dollar. Higher dollar will make dollar denominated gold cheaper. Thus going by the recent history it should mean gold prices would remain stable for Indian investors as even rupee may fall against dollar. But this time it may not be the case.

Why gold prices may fall now?
Although rising dollar usually means depreciating rupee, magnitude of depreciation depends on underlying fundamentals of Indian economy. When rupee had touched all-time low in August, market sentiment was bad and Current Account Deficit (CAD) was high. CAD simply means a country owes more to rest of the world than what it is entitled to receive from. Higher the deficit, bigger is the problem of financing it. But in the recent times current account deficit has fallen substantially. From the high of 6.7% of GDP in the 3rd quarter of Financial Year (FY) 2012-13; the CAD has fallen to 1.2% of the GDP in the 2nd quarter of the current fiscal. Revival in exports and cooling imports (on account of import curbs on gold imposed by the government), helped India lower its CAD drastically. Moreover, India's foreign exchange reserves grew by nearly 15 billion between September and November; suggesting pressure on Balance of Payment (BoP) may ease. To improve inflows of foreign currency, RBI had launched a swap facility for banks to attract foreign capital through FCNR-B deposits. Banks attracted 34 billion US dollars over last 2 months. This was a much better response than what was expected at the launch of this facility. Outcome of state assembly elections also raised the investor sentiment. These developments kept rupee strong.

What should you do?
For aforesaid reasons, this time it is unlikely that the rupee would tumble in case US dollar rises. Sharp fall in the current account deficit and robust inflows of dollars over last 3 months may provide support to the rupee. Pace of winding down of monetary stimulus in the U.S. too would have an impact on rupee. Gradual rollback may not hurt rupee as bad as it may otherwise do in case U.S. goes in for a drastic reduction. Furthermore, outcome of forthcoming Lok Sabha elections would affect the sentiment of foreign investors eventually affecting the value of rupee. Subsequently if the government believes threat of widening CAD has reduced, import duty on gold might be rolled back giving rise to pent-up demand. This should support gold prices. Considering all these possibilities, PersonalFN believes that gold prices might soften going forward.

PersonalFN is of the view that, gold is not the asset to make quick gains and should only be treated as a portfolio diversifier. Therefore, irrespective of where gold prices move hereon, investors should continue to allocate 10%-15% of their portfolio to gold. Gold acts as a hedge against inflation in the long term.

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