Would gold continue to shine in 2013?   Jan 31, 2013

Gold has historically being considered as an important asset class mainly for three reasons:

• Hedge against inflation
• Adds stability to the portfolio
• Asset Allocation avenue
  
  

And as Indians, many of you will agree, that most of us have an insatiable appetite and flair to own the precious yellow metal (which makes India the largest consumer of gold). We keep buying gold to take refuge during uncertain times, protect against rising cost of living or buy with some financial goal in mind – say, accumulating it for child’s marriage. So there are varieties of reasons why people evince interest towards the precious yellow metal, and thus the importance of it in one’s portfolio cannot be undermined.

Although other asset classes such as equities and real estate have lured many in the past and still continue to lure some, gold yet continues to attract many as it is perceived to be a store of value. Well, this is because the negative correlation which gold expresses with other asset classes. You may have observed many instances in the past that when the equity and / or the real estate market were on a downswing, gold continued to trend up and therefore looked bold.

Gold vs. BSE Sensex

(Source: World Gold Council, ACE MF, PersonalFN Research)

The chart above may help you get a distinct view how gold and Indian equities have moved since the emergence of the U.S. sub-prime mortgage crisis in January 2008. If one were to invest in the precious yellow and Indian equities (the BSE Sensex) on January 28, 2008, today one would have yielded returns of 158.7% and 10.7% respectively.

Today with the Indian rupee depreciating (which elevated the landing cost of gold), the precious yellow metal in rupee terms is at Rs 30,575 (as on January 25, 2013). Yes, in the last half a decade the prices have appreciated swiftly and many would wonder if it makes sense to allocate some portion of your hard earned money towards gold in 2013.

How will gold pave its path going forward?
Well, if we take closely observe of what is happening in the global economy, smart investors are likely to take refuge under the precious yellow.

Speaking about the U.S., with the fiscal deal being struck (by the U.S. Senate) at the end of 2012, it has averted fiscal cliff and therefore imbued confidence. By focusing on increasing taxes and holding back on stimulus measures, the U.S. seems to show resilience in the intermediate (3.1% GDP growth rates in third quarter of 2012). But the Euro zone debt crisis are yet sending shivers to the global economy and economic tension continues to prevail. Although bailout package for Greece and loan restructuring for Spanish bank has been permitted, it may not be too long before fresh crisis from the Euro zone emerge because the long-term worries yet remain, and even the stronger nations in the Euro zone such as France have experienced their sovereign ratings being cut.

While most central banks are adopting easy monetary policy (to handle the economic slowdown and their fiscal situation), it is likely to be supportive for gold. The idea in the western economies of printing more currency (for it to be used as reserve currency) to solve their sovereign debt crisis seems to inflict more long-term problems such as devaluation of currency and inflation, for the developed economies and thus may act a catalyst for long-term trend in gold to remain intact.

Heaping-up gold

(Source: World Gold Council, PersonalFN Research)

Probably recognising the perils of easy money policy central banks worldwide have built up gold reserves in order to shield themselves against the economic adversities. The chart above makes this evident, as most nations – especially the developed ones, have elevated their amount of gold holdings as a percentage of their forex reserves.

As far as India is concerned, the country has been caught into a vicious circle of economic jugglery.

First, the fiscal deficit target of 5.3% for the current fiscal year may be breached; although the Government is quite ambitious on its path of fiscal consolidation. Due to ballooning deficit, rating agencies have warned of axing India’s sovereign ratings and if this situation continues or worsens, it would not be too long before they rate India as "junk". Stating that the Government is likely to miss its fiscal deficit target for the current financial year, rating agency Fitch said India may face a credit ratings downgrade in the next 12-24 months. Standard & Poor's had also warned that India still faced one-in-three chance of downgrade in its sovereign rating to junk grade over the next 24 months citing high fiscal deficit and debt burden. "A downgrade is likely if India's economic growth prospects dim, its external position deteriorates, its political climate worsens, or fiscal reforms slow," the S&P had said in a statement. Moody’s however at present has retained its “stable" outlook for India (by maintaining a Baa3, lowest investment grade) citing potential for growth, robust domestic savings rate and a dynamic private sector. But in its report it has also stated that weak government finances, policy constraints due to politics, susceptibility to inflationary pressures and infrastructure bottlenecks, pose to be the challenges before India. Also the rating agency has cautioned that an increase in government debt ratios could trigger a downgrade.

Second, India’s Current Account Deficit (CAD) widened to 5.4% in the second quarter of the current fiscal year and that too is a matter of concern as it could lead to Balance of Payment problem for the country. While the Government has raised the custom duty on import of gold to 6% at present (as it could aid in curbing gold imports), we think that would not impede the demand for gold in India and in fact buoy up import of gold through an illegal activity such as smuggling. Likewise lower gold imports, could hurt jewellery exports. So it is quite a tricky situation given the robust consumption story of India while the Government endeavours to reduce CAD.

Third, the Indian rupee continues to be susceptible to weakness. Although the RBI in the recent past stepped in to arrest the fall by selling USD (worth $921 million in November 2012, up from $95 million in October 2012) it may not help in the India to stabilise. Also a noteworthy point is that, the sale of Greenback has an impact of draining the foreign exchange reserves in times when the country is experiencing ballooning CAD. So unless, the macroeconomic fundamentals do not show signs of improvement, the Indian rupee in our view would continue to remain under pressure.

Fourth, while the Government has removed the subsidy on diesel and most fertilizers in an effort to at least be closer to its fiscal deficit target, it is likely to build in inflationary pressures in the economy. The increase of 45 paise every month is likely to infuse inflation in primary articles and fuel. Also since diesel is an essential transport fuel, the effect of this is also likely to be seen on food inflation. Likewise the rise in rate of non-subsidised Liquefied Petroleum Gas (LPG) (i.e. over 9 cylinders) is likely to disturb household budgets (as it cost Rs 942 in Delhi). Thus far, the inflation monster continues to haunt the RBI and therefore we haven’t seen strong signals of any aggressive rate cuts.

Fifth, the quarter-on-quarter economic growth rate clocked by our country has also slowed down due to negative ripples seen earlier from the global economy and to near to high policy rates seen so far. The recent IIP data for November 2012 at -0.1%, has proved that October 2012’s sharp impulse was a mere positive statistical effect and to an extent supported by festive season.

Thus the aforementioned downbeat economic factors we believe would result in gold pricing stabilising near the present levels and in fact the long-term secular trend is likely to remain intact, as investor will approach gold as store of value in times where uncertainty yet prevails and long-term economic problems are not done away with. Any intermediate marginal correctives in our view would encourage many to buy gold. The demand for the precious yellow metal is likely to remain robust from India and China. In India, the rise in demand due to on-going wedding season is likely to enable prices to linger at elevated levels. Also with most central banks increasing their gold reserves, not forgetting that risk to the global economy yet remain; demand seems to be broad and global phenomenon. In times where cost of living (i.e. inflation) is on a rise, gold would be used as a hedge and it would find place for strategic allocation in the portfolio, of smart investors.

At PersonalFN, we recommend that you should have a minimum of 10%-15% allocation to gold. Invest in gold with a long term perspective with a time horizon of 10 to 20 years. While investing in gold prefer Gold ETFs as they help you reduce your holding cost considerably along with host of other benefits.

To read our view on how equities are likely to perform in 2013, please click here

To read if bond markets are poised for another rally in 2013, please click here

This article was written exclusively for Equitymaster, India's leading Independent research initiative. Trusted by over a million members all over the world, Equitymaster is known for its well-researched, unbiased and honest opinions on the Indian Stock Market.

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