10 years of stability shows gold is best hedge against risks in equities

A weaker dollar, stretched valuations in stocks and declining crypto currencies could induce volatility in gold, going forward

Volatility in gold prices last year has been the lowest since 2005, indicating that it is now re-emerging as an asset class alternative to hedge against risks in other investment avenues such as equities. Volatility in gold prices touched 7.4 early this month and is now at 7.6, the lowest since May 2005.

Sudheesh Nambiath, Senior precious metal analyst, SE Asia, GFMS Thomson Reuters, says “Volatility is low across various assets, and the reversal in its trend is historically associated with uncertainty. Markets may not have yet factored in potential risks. And any risk event would result in increased volatility, which tends to support a case for higher gold prices.”

The potential risks are already on horizon. Equities have heated up with prices and indices trading at all-time highs across the globe, including in the US, India and HongKong. Metals, crude oil, major foreign currencies (against the US dollar) and even crypto currencies are scaling new heights from a year ago.

Gnanasekar Thiagarajan, Director, Commtrendz Research, agrees. He says, “Volatility in gold has been on the decline right from 2012. Low periods of Volatility lead to fewer price swings and correspondingly lower volumes. Normally, this indicates a bearish bias and the decline is usually slow”. 

As far as gold is concerned, prices in general have been quite stable during the past five years and the trend will reverse when there is some trigger for the metal to start rising.

Gnanasekar explains, “The year 2009 saw peak volumes in gold after which there was a decline. However, in May 2017, volumes even overtook the 2009 highs briefly. Crude oil displayed a similar situation of flux with low volatility. However, larger triggers such as the Opec cuts have seen volatility increase lately. Similar triggers for gold are expected after which prices are likely to start rising. A weaker dollar, stretched valuations in stocks and declining crypto currencies - bitcoin prices could potentially be triggers -- could induce volatility going forward.”

Gold prices grew steadily between 2008 and 2012. However, after reaching a high of $1,900 an ounce, they stabilized at $1,250 levels. During the past one month, gold price have seen some uptick with risks rising.

In India, more than prices, it is the volumes on the Multi Commodity Exchange that fell prey to falling volatility. Trading in MCX gold futures, in terms of both quantity and value, has fallen sharply. In fact, in 2017 the average volume was about a fourth of that in 2013. Of course, the imposition of commodity transaction tax in July 2013 had also played a significant role in lower volumes. Low volatility reduces the price hedging requirement in general, leading to lower volumes.

Even the recent launch of gold options on MCX has seen falling volumes despite 2-3 settlement cycles is also because of low price volatility.
 

Says Ajay Kedia, Director, Kedia Commodities: “Both realised and implied volatilities in most asset classes are close to all-time lows. However lower volatility in gold has a message, as it comes despite heightened economic, political, and monetary uncertainty. It is our opinion, rather than buying volatility, it is better to be long gold.” 

Kedia explains that volatility rising from low means fall in equities and positive for gold. In 2018, gold volatility is most likely to increase, in which case the equity markets will suffer.