Broker’s Blurb: GOLD LOSES ITS GLITTER

There is a significant and growing consensus among academics, independent researchers and asset allocation experts that gold is a hedging instrument and a safe haven asset. Thus, many finance professionals now believe that gold should form part of investments’ and savings’ portfolios for reasons of diversification and financial insurance. However, what are considered safe havens alter over time as market conditions change, and what appears to be safe investment in one down market could be a disastarous investment in another down market.

Looking at the price trajectory the safe haven status is losing its significance. Gold is down about 17 per cent since it peaked in mid-March at USD 1,380 an ounce. But it’s been on a steep decline lately with prices sinking 9 per cent since October 21. The sell-off in gold began when the metal broke through USD 1,180 - the lowest level reached during a 28-per cent plunge last year. Strength in the dollar and breaks below key support levels have continued to drag on gold prices. The macro-economic data from the US released suggests that optimism in the US economy is gaining traction. The Manufacturing Purchasing Managers Index which measures business conditions in the manufacturing sector of the concerned economy has consistently registered values of over 50 for all months in 2014. 

The dollar index has been a major beneficiary of improvement in the US economy. The index has risen from the 85.40 mark on October 21 to the 88.134 mark as on November 6, gaining by around 3.2 per cent. On a year-to-date basis, the index has gained by around 10 per cent. Since the dollar index and commodity share inverse co-relation the rise in the index has led to a fall in the yellow metal.

The US’ central bank has amassed a balance-sheet of USD 4.48 trillion since it started its quantitative easing strategy in November 2008. Improving market conditions, including diminished fears of persistently low inflation and a steadily descending jobless rate, led the Fed to make the call to put an end to its third round of purchases last month i.e. October. According to the Fed’s statement, the committee is remarkably upbeat about the economy’s prospects. The unemployment rate has fallen to 5.9 per cent last month from a high of 10 per cent in October 2009.

The actions by the European Central Bank have also had a due impact on fall in gold prices. Low inflation in the Euro zone has been a prime area of concern for Mario Draghi and is acting as a threat to economic recovery. The ECB has cut interest rates in addition to announcing two bond purchase programmes. Also, the euro traded at two-year low against the greenback after ECB President Mario Draghi’s recent comments signaled that the ECB would pump more money into the Euro zone economy in a bid to revive growth. The ECB’s actions have weakened the euro and strengthened the dollar, in turn exerting downside pressure on gold prices.

Drop in gold holdings in SPDR Gold Trust (the world’s largest ETF) also reflects weak investment sentiment towards the yellow metal. Holdings as on November 6 stand at 732.83 tonnes, a six-year low. On a year-to-date basis, gold holdings have declined by 65.39 tonnes or 8.19 per cent, indicating waning interest in gold as an asset class. The speculative interest in  commodity has also been declining since mid-March this year. As on October 28, 2014, money managers are long at 70,298 contracts - representing a decline of 49,744 contracts or 42 per cent when compared to March 25, 2014.

Gold prices in China typically rise at this time of the year and trade at a premium to Western prices ahead of the Lunar New Year holiday in February, which sees a large uptick in physical gold buying, particularly jewellery. The lack of demand is in line with data from the World Gold Council earlier this year that showed total global gold demand in the second quarter fall by 16 per cent to 964 tonnes, as both consumers and investors pared their buying. The loss of demand from both India and China for jewellery gold has hurt gold prices throughout the year as both previously helped offset the declining interest in gold from Western investors.

Outlook

Gold as a commodity has lost its sheen as the price correction this year coupled with the fall in recent weeks has led to the loss of interest by investors in the glittering metal. Slow physical demand from China and India, decline in speculative and investment interest, and actions by the ECB to lift up the Euro zone (weaker euro and dollar strength) will act as a negative factor for gold prices in the coming weeks.

Improvement in the key sectors of the US economy is a negative for gold prices. The QE3 programme has acted as a boost for gains in the industrial sector, housing as well as labour sectors. The decision by the Federal Reserve to wind up its QE programme has reinstated confidence in the US economy. The next major block is the timing of rise in interest rates which will be a drag for gold prices. In India, the loss of physical demand on account of restrictions on imports (although eased to some extent) and consumers’ reluctance to buy gold at current prices (expecting more fall) will be a major drag.

In totality, the yellow metal is set for further correction and spot gold prices (CMP: USD 1,142) in the international markets can go downward to the extent of USD 1,050 per ounce while MCX gold futures (CMP:Rs 25,305) prices can head lower towards Rs 24,000 per 10 grams.