Gold has risen sharply due to rising risk aversion
Over the month ended February 11, the price of gold has rallied 10.88 per cent in India. A variety of factors are responsible for this turnaround.
China's devaluation of the Yuan in January has led to fears of competitive devaluations by other countries. Market participants are also treating the sharp devaluation as a sign that the Chinese authorities may be more worried about the economy than they are letting on. The consequent rise in risk aversion across the globe led to safe haven buying of gold exchange traded funds (ETFs) internationally in January.
Weakening global growth prospects have also led to market participants lowering their expectations regarding a rate increase by the US Federal Reserve. The Fed had forecast four rate raises of 25 basis points (bps) each in 2016. The market now expects increases once or twice.
"The market will come to the conclusion that Fed rate hikes are going to be limited. As the Fed goes back on its own expectations, that should support a rebound in a broader basket of assets closely tied to the value of the dollar," says Chirag Mehta, senior fund manager-alternative investments, Quantum AMC.
The rally was also caused by an element of price-related buying. “Gold prices have fallen a lot. There is always a core demand for gold in China, India and East Asia that comes into play at low price levels,” says Abheek Barua, chief economist, HDFC Bank.
It would, however, be premature to conclude that this rally marks an inflexion point in gold’s fortunes. According to Mehta, the continuation of this rally will depend on data emanating from the US and Fed actions. He cautions that the rally, if it happens, will be accompanied by a fair share of volatility.
Barua is of the view that while there may be some upside left, the rally may not sustain for long. “Gold is being bought because there is uncertainty all around. But remember that we are in a deflationary environment. Gold is typically held as a buffer against inflation. That feature of gold as an asset class might mean that the rally may not sustain beyond a certain point,” he says.
What should you do?
Financial planners suggest that retail investors should not react to price movements and try to time their entry and exit in an asset class. “Retail investors should focus more on their own financial goals and link their investments to those goals,” says Ankur Kapur, founder, Ankur Kapur Advisory.
He says investors who have a specific need for gold should begin to accumulate it in small quantities. Those who don't have a specific need may buy the yellow metal to diversify their portfolio. Gold's weight should, however, not exceed 10 per cent of your portfolio. As with any other asset class, rebalance your gold holdings at least once annually so that its weight remains unchanged.
Sovereign gold bonds have emerged as a good option for investing in gold as they offer a return of 2.75 per cent and also give the benefit of price appreciation. For investors who want liquidity in their gold holdings, gold ETFs remain an option.
