09 Jun 2015 14:45 IST

Why investors are not too dazzled by gold

In India, initiatives by the Government to curb gold demand worked to the metal's disadvantage

Gold has been the most sought after investment over the last decade. But the yellow metal has been losing its sheen of late and investors are flocking to other investments. What has turned investors away?

The selloff in gold started in 2013 as the US Federal Reserve announced its plans of exiting the easy money policy. Investors, who were betting on rising inflation and buying into real assets like gold, took shelter in the dollar. A strong rebound in global equity markets also took some lustre off the precious metal. The physical market in gold has not been strong enough to absorb the outflows from ETFs (Exchange Traded Funds). In Asia, particularly India -- the largest market for gold in the world -- several initiatives by the Government to curb gold demand worked to the disadvantage of the metal.

US SPDR Gold Trust – the world’s largest gold backed exchange traded fund -- has seen its holdings shrink by almost 50 per cent in the last two-and-half years. A WGC report says that investors cashed in on about 1039 tonnes of gold held as ETF units since 2013.

The decade long rally in gold appears to have come to halt. Gold rallied from about $290/ounce in the year 2000 to a peak of $1920/ounce in 2011. But today, it quotes at $1200/ounce, frequently testing lows of $1180/ounce.

Inflation worries recede

US consumer inflation which was about 3-3.5 per cent in 2011, rising from a negative 2.1 per cent in July 2009, has since fallen. It averaged at 2 per cent in 2012, 1.7 per cent in 2014 and is now at negative 0.2 per cent. Contrary to most expectations, the US economy did not face inflation worries, despite several rounds of quantitative easing. Inflation in other parts of the world too, has also been tame. In the Euro zone, inflation has dropped from 2.5 per cent in 2012 to about 1.3 per cent in 2013 and is at zero per cent now (April 2015). Led by a meltdown in global commodity prices, Asian countries too have seen inflation drop. Asia’s inflation (ex Japan) as captured by Bloomberg has dropped from about three per cent in mid-2014 to 2.09 per cent now. Hence, gold which was essentially used as a hedge against inflation saw investors abandon it and chase other investments.

Dollar’s muscle power

While inflation has been much below the Fed’s target of 2 per cent, a rate hike is imminent now given the positive trends in the housing and job market. The unemployment rate has dropped from nine per cent in 2011 to 6.7 per cent in December 2013 and is under six per cent now. On the other hand, housing starts are up significantly and foreclosures continue to fall. April housing starts stood at a seasonally adjusted annual rate of 1.135 million, according to a release by the US Census Bureau and US Department of Housing and Urban Development. This is over 20 per cent higher compared to March and nine per cent above April 2014.

The Fed holds a positive view about the economy and has been hinting at rate hikes for a while now. Pricing in these expectations, US bond yields have been moving up and money has been flowing back into the US. The US dollar index which charts the value of the US dollar against six world currencies is at a multi-year high now. From 79.7 in June 2014, the US dollar index touched a high of 100.39 in March this year and is at 97.3 now. The equity benchmark index S&P 500 has rallied 52 per cent in the last two-and-half years. With equity and bond markets on a roll, it is no surprise that investors are turning away from gold.

No physical gold to back

Gold is also under pressure because of several naked shorts on the gold futures, say some commodity experts. Naked shorts mean selling without any physical gold to deliver. Data from US CFTC (Commodity Futures Trading Commission) suggests that every time short positions go over a lakh, gold prices fall sharply. Speculators who get jittery every time prices nose-dive, also add to the pressure. For instance in December 2013 when gold prices hit a low of $1182/ounce, the net short positions in Comex gold futures was 1,07,000. Recently, in March when prices again fell to $1183/ounce, the short positions in gold futures were over a lakh.

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