What the recent correction in gold prices means for investors

Gold was the best performing asset class of 2020, delivering a return of around 27% compared to 16% by the S&P Sensex. The high returns were said to have come primarily on the back of covid-19-induced uncertainty. However, as major economies across the world gear up to administer the covid-19 vaccine building up the hope that normalcy will return soon, the price of the yellow metal has come under pressure. Gold has corrected around 9% from its peak of ₹55,922 per 10 grams in August 2020 to currently at around ₹51,375 per 10 grams.

Even before the discovery of the vaccine, economic data across the world showed better-than-anticipated recovery. The International Monetary Fund (IMF) had revised its global GDP forecast to -4.4% in October 2020 from -5.2% in June-end. Such indicators have led to improvement in the sentiments towards riskier assets. Equity markets across the globe, including in India, have touched all-time highs.

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So does all this signal an end to the rally in gold prices or is there more steam left?

The gold rush

The upward movement in gold prices started in July 2019, much before the pandemic hit the world, on account of rising geopolitical tensions between the two major economies—US and China. Also, the economic growth was slowing down which forced central banks to go for quantitative easing to support growth. The excess liquidity led to depreciation of the US dollar and supported the rally in gold.

However, as the pandemic hit the world and economies went into lockdowns to limit the spread of the virus, the demand for the yellow metal, which is also considered a safe haven asset, shot up. Most investors dumped riskier assets like equities and rushed to invest in gold due to the rise in economic uncertainty post covid. Gold prices touched an all time high of $2,063 per ounce internationally, while in the domestic markets it touched ₹55,922 per 10 grams of gold. The huge monetary stimulus announced by the big economies, including the US, also supported the rally in gold.

Investors flocked to different gold instruments. Gold-backed exchange-traded funds (ETFs) and similar products (gold ETFs) recorded net inflows of 916 tonnes ($50.3 billion) in 2020 and is the highest yearly amount on record, as per data from the World Gold Council.

In India, gold ETFs and gold funds saw the highest ever inflow of ₹6,200 crore, according to data from the Association of Mutual Funds in India. Sovereign gold bonds turned out to be one of the most favoured mediums as they saw the highest-ever subscription of ₹11,884 crore in the eight issues since April 2020, showed data from the Reserve Bank of India.

The Correction

Experts believe that the recent correction in gold prices is short-term and long-term factors remain in favour of gold. “After a significant run-up—approximately 27%—in this fiscal, some correction in gold was warranted as dollar gained strength on the back of the resurgence of virus, lower than estimated fiscal stimulus and a tone-down in risk-on sentiment,” said Vinay Khattar, head, research, Edelweiss Wealth Management.

Although the economic recovery post covid has been quick but various macroeconomic factors indicate that gold will continue its upward rally in 2021, said experts. “Dollar weakening and monetary debasement owing to massive monetary and fiscal stimulus in the advanced economies, favourable demand and supply gap, a turnaround in cash flows of gold mining companies and the lower real prices of gold than in the previous peaks are some of the factors that are aligning for a gold run in 2021,” said Khattar.

Also, experts believe that vaccinating a huge world population of more than 7.8 billion will be a humongous task. “Yes, the vaccine is out and deals have been made to roll it out in the economy, but it is important to understand that with the vaccine, there are yet a lot of complications that are to be taken care of. We still face the question of mass production and distribution all over the globe, also there is mistrust between politicians and people which is not a good sign when it comes to a vaccine,” said Navneet Damani, vice-president, commodities research, Motilal Oswal Financial Services.

Most experts believe that the rally in gold prices is likely to continue in 2021. “The market narrative today may be about vaccines and the return to normalcy. But there is no ‘normal’ to return to. Global policymakers will continue to resort to monetary inflation, credit expansion and government spending to tackle the extraordinary economic fallout of the pandemic. Use of this increasingly impotent monetary policy will mean failure to normalize the world economy as central banks will be trapped in a state of perpetual policy manipulation, financial systems will continue to walk on fiscal crutches, and the system will be marred with vulnerabilities. This will ensure that gold remains a preferred portfolio asset in 2021 and beyond,” said Chirag Mehta, senior fund manager, alternative investments, Quantum Mutual Fund, in a note released on the gold outlook for 2021.

“Going into 2021, the price is expected to extend its bullishness to test a fresh all-time high level of $2,400-2,500 per ounce. Whereas on the domestic front, the price is likely to extend its gains by a further 25% and test ₹65,000-68,000 level,” said Damani.

Mint Take

A 10-15% allocation to gold is advised for portfolio diversification. “One should buy gold on dips. Any further strength in the dollar will reflect in correction in gold prices and we suggest a staggered deployment of funds in gold. Below $1,750 per ounce levels, one could increase the overall allocation of the portfolio,” said Khattar.

Given its negative correlation with riskier assets such as equities, gold works as a hedge. Align your allocation to your goals.