Sowmya Sundar
Archana Venkat

The unstoppable rally in gold has made investors world over flock to it and rethink their portfolio allocation to the precious metal. With the recent meltdown, is this the right time to invest in the yellow metal?

The shimmer is back in the yellow metal after two dull decades, and it looks like the glitter is here to stay despite the recent meltdown that dragged the price down almost 10 per cent from its highs. Gold has had a dream run over the past four years, after it emerged from the low of $250 per ounce in 2001 to touch a high of $730 by mid-May 2006. The unstoppable rally has drawn investors the world over to the precious metal, and made them rethink their portfolio allocation to gold.

However, the metals meltdown over the last two weeks has taken some sheen off the metal and made investors wonder if this is the end of the bull rally.Consider this: The total gold held by exchange traded funds (ETFs) in May 2006 soared to roughly 445 tonnes, that is, 12 per cent of the total demand in 2005. In contrast, ETFs held just 39.4 tonnes in 2003. Gold ETF, typically, is an Exchange Traded Mutual Fund Unit listed and traded on a stock exchange, the precious metal being the underlying asset.

The sharp and consistent rise in gold prices has kindled investors' interest, prompting them to sink more money into the metal. Tensions in West Asia due to Iran's stance on nuclear weapons, soaring oil prices and the weakening dollar have only made the case stronger for gold as a safe haven, a hedge against inflation and a protection from the vagaries of the dollar.

Hot money flowing in

The political factors that elevated gold to the peak of $850 an ounce in the heady 1970s remain more or less the same. The difference this time is the quantum of retail investor money that is flowing into gold and what it can do to push prices up.

According to World Gold Council data, the total investment demand for the yellow metal has gone up 26 per cent, to 600 tonnes — about 16 per cent of the total gold demand. Since 2004, Gold ETFs launched in America, such as StreetTracks Gold Trust and iShares COMEX Gold Trust, have been the best performing funds; funds in India too expect to tap this market soon.

To get an idea of what this sharp pick-up in investment demand could mean for gold prices consider these facts. According to thebulliondesk.com, a precious metals research outfit, the value of gold held by ETFs by May 2006 was about $10 billion. Compare this with data from a World Gold Council report on pension funds. Pension fund assets in 11 major markets, including the US, Japan and the UK, amount to $16.4 trillion. Even if a fraction of these funds starts flowing into gold, it could be a major boost for gold prices.

Retail demand set to soar

Retail investors in India and China, and in West Asia too, are beginning to accumulate gold in forms other than jewellery. This trend is evident in WGC data, which point out that investment demand from these countries has risen 34 per cent, 32 per cent and 20 per cent respectively in 2005. This trend continued in the first quarter of 2006. Demand from gold ETFs rose 23 per cent in the period and was the single largest source of demand. These countries are also putting in place regulatory changes that could encourage investors to buy more gold.

In India, SEBI has given the green signal for launching gold ETFs. Considering that India is the largest consumer of gold in the world and most of gold buying is done with an ultimate investment objective, innovative products such as ETFs may become very popular. Investors are showing great interest in gold coins. On April 30 Akshaya Trithiya day, thought to be auspicious for buying gold, ICICI Bank alone sold about 1,000 kg of gold through its 600 outlets.

The volumes on gold futures too have risen sharply. According to NCDEX data, gold futures turnover has soared 70 times, from Rs 660 crore (1.1 lakh kg) in 2004-05 to Rs 47,600 crore (6.5 lakh kg) in 2005-06. Gold futures comprise 12 per cent of the total volumes on NCDEX.

China, by this year-end, will ease regulations to allow investors to trade in gold using US dollar accounts. So far they had to trade in the local currency. Gold can be used as a hedge against possible renminbi appreciation as and when China decides to revalue its currency.

The Chinese Government has also corrected taxation anomalies in buying gold. Tax will be levied only on any value added in the country and not on the intrinsic value of gold. These regulatory changes could spur interest in gold in the country. Chinese demand for investment by end-2005 was marginal, at 11.7 tonnes, compared to its jewellery demand of 241 tonnes. But this may go up when regulations ease.

Investment demand

A Gold Field Mineral Services (GFMS) report suggests that investment demand exceeded 28 tonnes in Thailand in 2005. The share of investment demand in total demand increased to 35 per cent in 2005, against 10-15 per cent in 2004. In West Asia, gold continues to be a favourite asset class. The excess money supply in the economy due to soaring oil prices may find its way into gold.

With investment demand for gold set to surge across the board as geopolitical factors look to remain unchanged in the near to medium term and supply being tight, prices may go up again. However, the upward move may not be consistent and will be interrupted by frequent downward price shocks, as seen in the last three weeks, as institutional investors have a big say in day-to-day price movements. There will be frequent profit bookings, which could become attractive entry points.

Right time to invest?

Even as demand-supply dynamics and political conditions suggest that gold could just be at the beginning of a long bull run, the metal meltdown on the London Metal Exchange during the week sent jitters through the investing community.

A slew of reports from the who's who of the financial world declare stridently that commodities are overvalued now, though the long-term outlook remains bullish. So, is it the right time to invest now? "Yes, it is. Gold is a scarce commodity, and its price is bound to go up because no new gold mines have been discovered recently to increase supply," says Mr Sachin Haresh Bhatia, Branch Manager, ICICI Bank.

Experts in the commodity circles, too, are bullish. Mr S. Venkataraghavan, Vice-President, Research, Altos Advisory Services, a commodity broking firm, said: "We have a very bullish outlook on gold in the long term and have a price target of over $770 an ounce by December 2006. This is backed by the premise that the dollar might remain weak and oil prices will firm up, leading to global inflation."

Mumbai-based commodity broking firm Man Financial is even more bullish and expects gold to cross $800 per ounce in the next three to six months.

However, in the short term, commodity analysts agree that gold prices may remain volatile due to large fund activity, profit booking by funds and huge amounts of money flowing into gold ETFs. "Investors can look at the price dips to invest in gold," says Mr Venkataraghavan. Ms Rajini Panicker of Man Financial says gold remains a good buy on dips below $650.

Gold recently touched a five-week low of $630 an ounce and is showing some signs of resistance. It may be a good time to enter. However, spacing out your gold purchases over a period using dips may be a better strategy.

How much to hold in gold

As prices of the precious metal soar, should you shift your assets to gold? Yes, a part of it definitely. Altos Advisory Services suggests that one's portfolio should contain at least 5-7.5 per cent in gold.

With the equity market peaking out, one can expect it to be largely range-bound in the near to medium term. However, one cannot ignore equity. Investors can expect returns of 20 per cent from equity over the next couple of years, provided a bottom-up approach is followed.

Interest rates are edging up and debt too is regaining prominence as an asset class. A fixed deposit could fetch you close to eight per cent now. In this background, gold definitely looks attractive from a two-to-three-year perspective. But do brace yourself for that roller-coaster ride in gold too.

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