It’s time to rethink your approach to gold

The 3.5% sharp fall in global prices of gold on 20 July was unexpected despite the bearish trend in the precious metal. The 0.6% rebound in prices the very next day was also surprising, but underlined the notion that the sell-off and panic might have been overdone.

Global macroeconomic conditions are such that gold prices are unlikely to move much higher and indeed may decline more. But do lower prices beckon an increase in your investment allocation? To know the answer we must first understand why prices are falling.

The foremost impact on gold prices come from the way the dollar moves. Although the gold peg (converting dollars for gold) ended 45 years ago, the relationship between the two remains—gold price rises when dollar is weak, and vice versa.

The dollar is considered to be one of the safest assets for investment and when it weakens, money moves to gold, which is considered a store of value for any currency. Moreover, if weakness in the dollar is seen in the backdrop of a bearish trend in US equities and bonds, that too can lead to higher demand for gold. But if the reverse happens and a stronger dollar is accompanied with high growth or a pick-up in the US economy and strong equity and bond markets, demand for gold is likely to fall.

This is what experts suggest is now leading to lacklustre investment demand in gold. Combine this with an improved demand globally for risk assets such as equity, and gold gets overshadowed. Global demand from exchange-traded funds (ETFs), which had shot up till about three years ago, has reduced.

As a result of these factors, price has corrected around 40% from its peak of $1,900 in August 2011. But some interest has returned at these levels; World Gold Council data shows that after seven quarters of being sellers, globally ETFs reported net purchases for the first quarter of 2015.

“Prices are likely to stabilize at $1,000-1,050 because below that production is unviable. But the bearish trend is likely to continue,” said Naveen Mathur, associate director-commodities and currencies, Angel Broking Ltd. In India, he expects, that at price levels of 24,000-24,500, the consumption demand for physical gold may pick up with festive season around the corner.

Time to buy?

Historically, a rally or a bearish trend in gold prices has lasted for periods as long as 10 years. The recent fall in price has come after a 12-year rally. Also, macroeconomic conditions globally are not supportive of any near-term rally in prices, and an interest rate hike by the US Federal Reserve can dampen sentiment and gold prices further. Therefore, even if prices don’t fall much in the near term, a rally, too, is not likely soon.

An investor must keep in mind that gold is only a store of value. Though it is a hedge against inflation, price gain is subject to global factors. At present, most of these factors are negative for gold.

“You have to think about why you are buying gold. Inflation is likely to be low for some time and impact of international factors is evident. Don’t invest in gold just because prices are falling,” said Hemant Rustagi, chief executive officer, Wiseinvest Advisors Pvt. Ltd.

Gold is a store of value and a long-term hedge against inflation, and for that purpose it is recommended not to have more than 5-10% of it in your overall portfolio.

It’s time to rethink long-term accumulation of gold. If you need gold for near-term consumption, then the current price is good. But if you are buying with a long-term goal in mind, say, after 10 years, you will be better off investing for 5-10 years in growth assets such as equity and using the gains to buy gold when you need it.