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An interesting trend of the recent past has been the collapse of gold as an asset. The precious metal has been steadily sold down, losing 16 per cent between January and July. Global prices hit five-year lows last week.
This is odd at first glance, since gold is seen as a store of value in difficult times and the world is definitely going through difficult times. There is financial tension in Greece and China, war in West Aisa, conflict between Russia and Ukraine, and slow global growth. There has been turmoil in equity, bond and currency markets. Under such circumstances, gold usually gets bullish.
But while turmoil could make gold more attractive, low inflation makes it less attractive. Gold is seen as a great hedge against inflation but most major economies are struggling with deflation. Japan, Europe and the US would be delighted if inflation rose. Even China's inflation is below 1.5 per cent.
India has been an outlier on inflation for two years. Even now, inflation in India is well above global levels and India is traditionally one of the two largest gold importers in the world. Gold prices saw an earlier correction in 2013, Indians bought heavily. In fact, the high level of Indian purchases was cause for concern when the rupee came under pressure in 2013. Gold was the second largest contributor to imports behind crude oil. China, the other large gold importer, also bought heavily in 2013.
That pattern has not been replicated, though prices are nominally lower than in 2013. India's middle class seems to be opting for equities and debt, if we go by the rising assets under management of mutual funds. For what it's worth, slow rural demand has probably hurt gold as well. Until the monsoon picks up, rural demand will stay under par.
While India has not been a big buyer, China has seen massive sales in the past fortnight. One reason could be the existence of highly leveraged stock market positions. While desperate measures have stemmed the rout, many Chinese shares are not being traded at the moment. Anybody in China sitting on a highly-leveraged position (or a promoter who has pledged shares that have lost value) might face margins calls and also not be able to dissolve the position. Such persons may be selling gold to raise cash (or offering it as collateral to somebody who sells it).
There are more long-term reasons for gold bearishness. For one thing, the US Federal Reserve is threatening to start raising rates. Everybody expects a stronger dollar as a result and that will mean cheaper gold because the international price is dollar-denominated.
The yellow metal tends to have very long historical cycles and Indian prices follow international trends. Gold hit all-time highs of above $1,800/troy ounce (the troy ounce=31 grammes) in 2011. It is now below $1,100. That is a substantial correction. But the long-term record shows gold has literally spent decades trading below $400. Given that record, it could definitely trade lower.
Commodity traders often assert a relationship between crude oil prices and gold and the two tend to move in the same direction. This makes intuitive sense since fuel prices do affect inflation. High crude oil prices generally mean higher inflation, which usually means more interest in gold as a hedge, and could drive up the price.
If this correlation exists and holds, gold should slide further, since crude oil is expected to trend down over the next few months. Balanced against that, India has its festive season coming and if that coincides with lower gold prices, it could spark renewed buying. Similarly, if the Chinese stock market loses more ground, Chinese retail investors might again start looking at gold as an asset.
The consensus on gold right now appears to be "sell" or "strong sell", with few people suggesting otherwise. There could be more supply if central banks and governments holding large quantities in their reserves decide to trim exposure to the metal.
Net-net, gold will gain if global growth slows and there's higher inflation, or some sort of currency collapse occurs. Gold will lose more ground if global growth improves, even if inflation rises. Gold could also lose ground if growth slows and inflation does not occur. The chances are, there is still a downside.
