Go For Gold In 2019!
While most of the investors were focused on equity markets and the political events in India that may impact equity returns, one asset class that is widely held by Indians managed to show an impressive performance without making a lot of noise. Gold is up by 7.3 per cent in CY18 and is up by 1.82 per cent on YTD basis in 2019. Gold outperformed equity yet again in 2018 as it did in 2008, 2010, 2011 and 2016.
Time and again the importance of asset allocation is discussed in financial literature. It is a known fact that the amount of wealth that any investor would generate is a byproduct of asset allocation in the long term. The outperformance of gold in 2018 shows the importance of being invested in the asset class. Indeed, for any investor, getting the asset allocation right is not only essential, but also the key to minimizing risks in investments. Smart investors have been taking exposure in the precious metal not expecting superior returns alone. The intention is to create a portfolio that delivers on a risk-adjusted basis. Gold can be an essential component of any portfolio that needs to deliver returns on a risk-adjusted basis. Says Sachin Surse, a seasoned investor, “ I always believed in asset allocation strategy and have focused on getting it right from the beginning. At any given point of time, I am invested in gold, equity, real estate and debt. After equity, if there is any other asset class that I am happy with, it is gold, as it has not disappointed me in terms of returns. And yes, it gives me the much-needed diversification in the overall portfolio and the best part about gold is its liquidity.”
"Multi-asset class investment approach can lead to smoother returns than investing in any single asset class."
Domestic vs international gold prices and exchange rates
The exchange rates and gold price relation is always a discussion point for investors. What matters for the investors is to know what happens with gold prices when the Indian rupee (INR) weakens and US dollar (USD) strengthens. The below chart compares the domestic and international prices of gold and also traces their movement along with the INR/USD exchange rate 2015 onwards. It is observed that the local gold rate was at a discount to the international rate for 745 days and at a premium for 301 days. This means that local gold prices were trading at a discount for more than twice the number of days the price was at a premium to the international rate. It can also be observed that when the rupee was weaker against the dollar, the local price was at a discount to the international price, and vice versa.
Demand for gold and a topsy-turvy year
In 2018, global gold demand rose 4.45 per cent on highest central bank buying in 50 years. The gold demand in 2018 touched 4345.1 t (tonnes), up from 4159.9t in 2017. This is in line with the five-year average of 4347.5t. The growth was driven by central banks buying 651.5t, a multi-decade high. The net purchases by the central banks jumped to their highest levels since 1971, as several central banks turned to gold for diversification.
The demand for gold as a reserve asset strengthened substantially in 2018, rising by 74% compared to 2017, in response to the geopolitical and macroeconomic environment. This was led by a desire to de-dollarize foreign exchange reserves in response to worsening geopolitical relations in some parts of the world.
The gold ETF inflows registered a 67 per cent decline YoY, with Europe being the only region to register net growth in 2018. The annual jewellery demand remained largely flat, down by just 1t from 2017. The Indian demand for jewellery remained stable at 598t. The gains in the US, China and Russia were broadly offset by losses in Middle East. Retail investments in gold bars and gold coins registered a 4 per cent growth. The demand for coins surged to reach a 5-year high of 236.4t. The demand for gold bars remained steady at 781.6t, remaining in the range of 700t-800t for the fifth successive year.
The usage of gold in technology saw marginal gains on the back of healthy gains in the first nine months of 2018, but the last three months witnessed a 5 per cent decline due to a combination of slowdown of smartphone sales, the trade war and increasing uncertainty regarding global economic growth. The annual gold supply stood at 4490.2t. Gold mine production increased 1 per cent to make a new record high of 3347t, supported by a healthy production pipeline.
In December 2018, amid a sell-off in global stock markets and a decline in the value of the dollar due to expectations of a slowdown in US interest rate hikes, investors sought refuge in gold. This resulted in the gold price ending the year near US$1280/oz. (-1 per cent YoY). Under normal circumstances, gold and dollar should share a perfectly inverse relationship, but the domestic prices are different from international prices due to factors like import restrictions, local demand-supply dynamics, seasonal factors, purity requirements and regulations.
Outlook for 2019
Many of the global factors seeded over the last two years and the risks that became apparent in the late 2018 are expected to carry over into 2019. This will lead to certain trends that will play a crucial role in determining the demand for gold. The interplay of these trends will determine gold’s short and long term price behaviour. Increased market uncertainty combined with expansion of protectionist economic policies would make gold an attractive hedge. The upward trajectory of US interest rates and the strength in dollar remain headwinds for gold; however, these effects are expected to be limited as the Federal Reserve has signaled more neutral stance, as a large part of the growth seen in the US was due to tax cuts which are unlikely to continue. The deterioration in credit markets of the US can be seen with spreads widening by more than 70bps since January 2018 lows, while credit conditions for consumers are tightening.
A few important global factors that make a positive case for gold are expensive valuations in the financial markets and high market volatility, political and economic instability in Europe, potential higher inflation due to protectionist policies and an increased likelihood of a global recession.
About 70 per cent of the gold’s global consumer demand comes from emerging markets. India and China are two countries that stand out as they have begun implementing the economic changes necessary for growth and to secure their relevance in the global landscape. China, with its Belt and Road initiative, is focused on upgrading infrastructure, boosting commodity markets and promoting regional economic development. India has been rapidly modernising its economy, promoting fiscal compliance and reducing barriers to commerce. Gold has an unequivocal link to wealth and economic expansion and is well-poised to benefit from these initiatives.
Gold has a dual nature: consumption and investment. The price drivers of gold can be grouped into four categories, namely, wealth and economic expansion, market risk and uncertainty, opportunity cost and momentum. As a consumer good and long-term savings vehicle, gold demand has been positively correlated to economic growth. As a safe haven, its demand historically has been high in times of heightened risk. In the short and medium term, the level of rates or the relative strength of currencies as well as investor expectations can either enhance or dampen gold’s performance.
The use of gold across sectors like technology, energy, etc. is changing rapidly. The position of gold as a commodity of choice is expected to evolve over the coming decades. The development of mobile apps for individuals to buy, sell and gift gold is expected to develop rapidly in India and China. The environmental and social factors and governance will play an extremely crucial role in reshaping mining production methods. The gold mining industry will also have to overcome the challenge of producing similar levels of gold to match the volumes it has historically delivered.
Extending Of Gold ETFs
The US physical gold-backed ETF industry continues to experience an average 27.3 per cent AUM growth per year in US$ terms since its inception 15 years ago. This has been driven by several factors, including the rapid adoption of robo/self-directed solutions, management fee compression, a wide range of options for exposures and ease of use relative to other investment vehicles.
Alistair Hewitt Director of Market Intelligence at the World Gold Council
"Following the multi-decade high in gold reserves growth in 2018, central banks' appetite remained healthy at the start of 2019. Gross purchases of 48 tonnes (T) and gross sales of 13T led to global gold reserves rising by 35T on a net basis in January, with sizeable increases from nine central banks. This is the largest January increase in gold reserves in our records (since 2002) and illustrates the recent strength in gold accumulation. Demand was concentrated amongst emerging market central banks with diversification being the key driver in the face of ongoing geopolitical and economic uncertainty."
FinTech’s growing role in the gold industry
The fin-tech community saw a heightened level of interest in 2018. A wide variety of different digital investment platforms have been launched worldwide and many are under development. These platforms seek to introduce new business models and disruptive solutions to redefine the current gold industry value streams as well as potentially increase gold demand.
Block chain has rapidly gained traction in the fin-tech space and seeks to ensure integrity in the global supply chain. In the future, fintech gold solutions are expected to be a significant driver for the markets. For example, Safe gold is a digital platform in India that allows customers to buy, sell and receive vaulted gold.
Conclusion
In conclusion, gold is perceived to have intrinsic value which is why the world’s central banks, the International Monetary Fund (IMF) and other financial institutions own over US$1tn worth of gold.
Dr. Alan Greenspan, the former chairman of the Federal Performance comparison (%) Gold Silver Brent Crude Sensex 2018 7.3 -2.3 -19.5 5.9 YTD 1.82 -1.37 17.73 0.77 Reserve, pointed out that the change in the prices of gold historically parallels the change in the general price level for goods and services, meaning it has an inherent stability when analyzed across decades or even centuries. The global factors and industry dynamics point to a positive outlook for gold in 2019.
For investors, the trick is to get the portfolio balance right in terms asset allocation. Gold as an asset class cannot be ignored by any type of investor.
In 10 out of 15 years since 2003, we find that both gold and equity as an asset class has generated positive returns. It looks like 2019 is going to be another year where both equity and gold will deliver positive returns.