Rally in gold may continue

There may be further upside, as negative real interest rates in developed world unlikely to end soon

Gold has risen about 26.1 per cent year-to-date in 2016. The strong rally in yellow metal has raised three questions for investors: Will the rally continue? Will it be prudent to make fresh investments at current levels? And, should existing investors stay put or book profits? Recent data from the World Gold Council for the first half of 2016 show the upsurge in demand for gold was driven primarily by investment demand from investors in the developed world — US, Europe and Japan. The investment demand of 1,063.9 tonnes during the first half of 2016 was 16 per cent more than the previous high in the first half of 2009 (after the financial crisis).

According to experts, the experimental policies being pursued by central banks in the developed world are causing investors to flee to gold. The normalisation of interest rates by the US Fed has been slower than the Fed had communicated. “Investors have come to believe that real interest rates in the developed world will stay negative for a prolonged period. This is the primary factor driving demand for gold,” says Chirag Mehta, senior fund manager - alternative investments, Quantum Mutual Fund.

High supply of money by central banks is causing devaluation of currencies. “Gold is one asset that can’t be printed and released into the system,” says Lakshmi Iyer, chief investment officer (debt) and head-products, Kotak Mutual Fund.

Experts believe that the rally in gold is likely to continue. Prateek Pant, co-founder and head of products and solutions, Sanctum Wealth Management, says “Negative interest rates and surplus liquidity conditions will continue to prevail in developed world for some time. Given these conditions, gold is a good asset class to stay invested in.”

The Fed may at best hike rates once this year, a scenario that will be bullish for gold. Other events like the UK invoking Article 50 as a formal announcement of its exit, a divisive US election, a possible collapse by one of Europe’s over-leveraged banks, or devaluation of the yuan could lead to heightened volatility and more investors fleeing to gold.

Despite the run-up, gold may not have peaked yet. “During the last rally, gold’s price in the international market had gone past $1,900 per ounce. If investment demand remains strong, there could be more upside to the present prices,” says Pant. At $1,351.50 per ounce currently, gold is way below its previous peak. Investors who don’t have an exposure to gold may invest even at current levels. Says Mehta: “We have run numbers which suggest that investors should have a 10-15 per cent allocation to gold at all times. This level of allocation has the potential to reduce portfolio risk considerably without affecting returns.” In his opinion, investors who don’t have this level of allocation may invest even after the run-up of the past year.

Opinions vary regarding whether investors who invested earlier should book profits at this juncture. Pant is of the view that if an investor does any profit booking, it will be difficult to reallocate to other asset classes as both equity and debt (especially government securities) have run up in the recent past and are not inexpensive. Iyer, on the other hand, believes that if an investor’s allocation to gold has gone above his model allocation, he may rebalance. In our view, while aggressive investors may stay put, conservative investors should sell and rebalance.