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Gold has recovered somewhat from the 14 per cent collapse it experienced between April 12 and 15. In rupee terms, it has fallen to a 20-month low of Rs 23,500 per 10g. It appears the dramatic decline in the price was driven by very high volumes and intensity of activity as traders hit stop-loss levels, triggering automatic sales orders. Importantly, the Cyprus financial crisis and North Korea's continued military threats have not prompted investors to buy gold as a safe-haven asset.
Another reason why gold is faring poorly could be the dollar's robustness. The currency has been buoyed by suggestions the Federal Reserve might pull back on quantitative easing as the growth outlook stabilises in the US. Other factors clouding gold's outlook include the Bank of Japan's commitment to pushing the yen lower by purchasing $1.4 trillion in bonds over the next two years and concerns about the Euro zone. Both factors help the dollar. Therefore, the dollar is expected to maintain its surge, pressurising gold prices.
The European Central Bank's advisory that Cyprus sell gold reserves to cover some of its bailout costs has shaken investors' confidence. Cyprus holds, from an international perspective - an extremely modest 14 tonnes of gold reserves, less than four per cent of the daily traded average volume of the metal. Yet, there is a larger point. The step sets a dangerous precedent that other Euro zone central banks might be forced to follow. It also confuses the picture in terms of gold's future role in securing national currencies.
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Still, the recent sell-off looks exaggerated. Selling by global gold exchange-traded funds (ETFs) has now unwound almost all of the purchases they made during the Euro zone crisis in 2011. So, we believe some central banks in emerging markets might consider buying at current levels. Also, many indicators point to a temporary consolidation in gold prices at current levels before declining further. This represents a potential further seven to eight per cent downside from current levels, or about Rs 22,000 per 10g in constant rupee terms.
We continue to believe that gold has place in investor portfolios, despite all that's happening. It is an alternative asset with the least amount of correlation to the traditional asset classes (fixed income and equities). We believe it will continue to play a role as a hedge against global macro-economic and geopolitical risks. However, it is also clear that return expectations need to be adjusted downwards, particularly when compared to the performance of the metal over the past 10 years.
In January, we trimmed gold positions in portfolios, as we expected the metal to underperform against the backdrop of an increasingly less fragile global economic recovery. We also saw underperformance against equities, which we attributed to a changing investment environment and shifting asset class correlations that started to become apparent during the last part of 2012.
We see gold prices being supported by three key factors. Expected central bank purchases, further currency devaluations as a result of huge quantitative easing internationally (enhancing its role as a permanent store of value) and reviving demand for jewellery. However, we think investors in India should also bear in mind that, given the improving outlook for the rupee, gold could underperform in local currency terms in comparison to the dollar. Although this is a near-term risk, we believe gold prices are now at attractive levels for buying.
The author is CIO, RBS Private Banking
