The current correction is temporary, add to your position in gold

With liquidity remaining high and real interest rates continuing to be low, gold is expected to do well for at least the next 18-24 months

At the start of this year, gold was trading at Rs 38,962 per 10-gram level. It then rose 43.5 per cent level to touch a peak of Rs 55,901 on August 7. Since then, however, the yellow metal has corrected around 9.4 per cent and is now at the Rs 50,636 level. This correction has left investors in a quandary, with many asking: Has the bull run come to an end, or does it still have some steam left? 

Correction is temporary  

The foremost reason for the correction witnessed seen since August is that the rally in the preceding months had been very sharp. “No asset class can keep moving up in a straight line. Corrections are a part and parcel of every rally and this one was expected,” says Chirag Mehta, senior fund manager–alternative investments, Quantum Mutual Fund. 

The US government was expected to come up with a fiscal relief package for its economy. “That relief package would have supported the next leg of the rally, but it got delayed due to the inability of the two major political parties to arrive at an agreement. Many investors have, as a result, booked profits in gold,” says Kishore Narne, associate director and head of commodities and currency, Motilal Oswal Financial Services. 

The reopening of economies around the world a few months earlier had led to a surge in optimism. Money had then started flowing from safe-haven assets like gold into riskier ones like equities. 

Yellow metal may surge further 

Experts are of the view that the rally is far from over as the fundamental factors driving it remain intact. While the fiscal stimulus in the US has been delayed, it has not got derailed. “Monetary stimulus by central banks has run its course and may continue. But fiscal stimulus will be required to pull up economies. We will see governments in the US, Europe and even emerging markets come up with fiscal stimulus packages, despite their stressed finances,” says Mehta. This will lead to more money flowing into the hands of people.  

Central banks may continue to print money both to keep the financial markets afloat and to help their governments fund their deficits. That could lead to debasement of currencies. The high fiscal deficit that the US government is accumulating could also cause weakness in the dollar. Since gold is priced in dollar terms, any weakness in this currency will be positive for the yellow metal. 

The bull market in gold has been driven by high money supply (liquidity) and cheap money (low or negative real interest rates). “These two factors will continue to prevail in the world economy for at least the next two years,” says Narne. He believes interest rates will move up only after two years. Markets usually discount developments in advance, so he is of the view that the outlook for gold remains positive for the next 18-24 months. 

With the US and Europe witnessing a second wave of Covid infections, restrictions on movement are being re-applied. The economic recovery in these countries could get delayed further. 

Experts say the extent of damage in the job market plays a significant part in determining how long it takes for an economy to recover. “Going by that criterion, it will take at least a few years for the major economies to return to normal levels,” says Mehta. He remains positive on the prospects of gold for two-three years. And historically, a rally in the yellow metal has lasted for at least four-five years. “The current rally has lasted for only two years, so one can expect it to continue for some time,” says Ajay Kedia, director, Kedia Commodities. 

The bearish scenario

In the unlikely event of global economic growth returning faster than expected, the bullish scenario for the yellow metal outlined above may not pan out. But even in that case, experts say investors should watch out for inflation. Fiscal stimulus, which will put money in the hands of people, could fuel inflation. Even if growth returns, if inflation rises, gold may continue to perform. At the same time, if high inflation leads to central banks hiking interest rates, that will be negative for gold. Keep a close eye on  real interest rates.   

      

What should you do? 

At any given point, investors should have an allocation of 10-15 per cent to gold in their portfolios. This level of allocation reduces risk and enhances portfolio stability without having a negative impact on returns. If you don't have this level of allocation, use the current price correction as an opportunity. “Investors who don’t have a 10-15 per cent allocation to gold should buy 50 per cent of the missing allocation now and spread out the purchase of the balance over the next six months,” says Mehta. 

Narne, too, is of the view that investors should hold on to their current positions in gold. “If the price comes down to Rs 48,500-49,000 level, add to your position,” he says. 

Finally, the demand for gold has slumped and could be much lower this year than the 696 tonnes consumed in calendar year 2019, according to data from the World Gold Council. “People are fearful about visiting jewellers’ shops. Household incomes have taken a hit. Fewer marriages are taking place. Also, people are recycling old gold,” says Kedia. If you are buying for investment purpose, you should stick to instruments like sovereign gold bonds, gold exchange-traded funds, and e-gold. On the other hand, if you wish to purchase gold for consumption purpose, you may try out leading jewellers’ web sites, as they have augmented their online channels in recent times.