Buying gold as a hedge at these prices may be dangerous as the appreciation may have discounted the fundamentals.
The price of gold, is by default, expressed in US dollars. When the dollar comes under pressure, gold sees a price rise. This is why gold prices have spiralled up above the psychological barrier of $1,000/ ounce (29 grams).
It is easier to accept this emotionally if you think of gold as a currency rather than a commodity. The dollar has weakened against most hard currencies in the past couple of weeks and gold, which is a hard currency, has been no exception. Traders who have been long Euro-short dollar have gained along with those who bought gold.
However, the hardening in gold prices is more than one would expect purely in terms of dollar weakness. If the rise in gold had exactly mirrored dollar weakness, the price would have been constant in Euro or Yen.
The appreciation in non-dollar terms indicates new economic uncertainty. That arises from the same root cause of a weak US economy. That fear is also reflected in lower GDP estimates for the PRC, which could possibly be overtaken this year by India as the world’s fastest growing economy.
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The PRC’s economy is an export-oriented engine and it’s unlikely to take over the US mantle as a global growth driver precisely because of that export-orientation. China’s growth is tied to the US and to a lesser extent, the EU.
While there may be some patriotic pride in the Indian economic resilience, India isn’t growing fast enough, nor is it big enough, to make a material difference to global GDP. Estimates have shifted up to an optimistic 6-6.5 per cent of GDP growth this fiscal, from earlier pessimistic estimates of 4-5 per cent.
That is still a much poorer performance than in the previous three fiscals. The relative outperformance versus other economies could attract larger shares of FDI. But India is not big enough to help the world economy turnaround.
There is also some doubt whether the second half of 2009-10 will see an Indian rebound of sufficient dimensions to match 6 per cent-plus estimates. Exports are still undergoing shrinkage though there should eventually be a reversal and bounce, if only because of the effect of lower bases through the second half of 2008-09.
Agricultural performance will be poor and although agriculture directly contributes only about 18 per cent of GDP, it has a key impact on consumer inflation and on consumer confidence.
Due to structural deficiencies, high food prices caused by production deficits only benefit a narrow range of middle-men. The negative effects show up in consumer price indices, which hit nearly 12 per cent by July. It shows up in lower offtake in consumer-driven industries, especially industries driven by retail loans. This too, is visible in the slower pace of home loans and car-sales.
Equity traders would also be worried over the fact that Indian shares appear to have already factored in better second half earnings. There may not be much upside left for shares at the current index valuations of above 20 PE.
The discounts are difficult to justify on any of the standard valuation metrics. It’s over 1 in terms of PEG ratio; it’s unattractive in terms of interest rate yields; it’s historically at the high end of average market valuations.
Ideally, one would advice traders to seek refuge in commodity markets. There’s obviously a bull market in food-baskets and probably, crude. But many of the key commodities are difficult or impossible to trade due to government bans. Or, they require very specialised knowledge.
Buying gold as a hedge at these prices may actually be dangerous. According to contrarian theory, the appreciation has made enough noise to completely discount the fundamentals. If there is any good news coming through, gold prices will dip.
Selling dollar on the widely-available Nifty currency future is a possibility. The problem here is that the rupee is highly correlated with FII attitude in the short-term. If the FIIs are net buyers, the rupee appreciates and vice-versa. Right now, FIIs are net sellers so the rupee may not harden as much as one would hope.
The most practical course of action may be to ignore fluctuations in gold prices. Instead seek value in cyclical industries, which are currently in bad shape. The returns would be more long-term in nature but there is far less of a downside in a focus on beaten down assets.