06 Aug 2020 17:09 IST

Will the gold rally last?

Uncertainty across other asset classes has pushed up gold demand, and prices may stay strong for a while

Gold prices have skyrocketed this year, due to the panic generated by the Covid-19 pandemic. The metal is trading at $2050 an ounce now, up 33 per cent year-to-date, outpacing all other asset classes. Investors and hedge fund managers are queueing up to buy gold in the futures and ETF markets, and this is pushing price of the precious metal higher and higher.

In countries such as the US, the UK and the EU region, a second round of stimulus is expected to combat the continued impact of Covid-19 on these economies.

It must be noted that an easy monetary policy makes paper currencies weak and forces investors to seek safety in gold. According to data from the World Gold Council (WGC), gold-backed ETFs globally have seen record inflows so far this year, adding $47.8 billion as of July 27. Interestingly, in the June 2020 quarter, demand for gold from investors (including those buying coins and bars) was 539.6 tonnes, which exceeded demand from consumers of gold jewellery, at 325.8 tonnes. The last time such a trend was seen was in June quarter of 2016 but, at that time, prices were far cheaper — at $1,182/ounce.

Why hedge funds cut long positions

Besides ETFs, demand for gold in the futures market is also strong now, thanks to hedge funds being bullish on the metal. Since mid-June, net long positions of hedge funds in gold futures has only been increasing. In March, and until middle of June, data from the US Commodity Futures Trading Commission (CFTC) on positions of hedge funds in gold futures implied that the gold price rally would lose the fizz as net long positions of the money managers were dropping. But now, looking back, it appears that it was the supply-side challenges in movement of gold from vaults and mines that made hedge funds reduce their long positions.

There are some interesting facts from the recent WGC report which force the conclusion that the yellow metal rally is not over. First, while in the previous rally between 2008 and 2011, the price doubled — from $900/ounce to $1,970/ounce — this time around, the increase in price has been just 30 per cent. Further, in the current year, the yellow metals’ three-month and one-year rolling returns have moved by only two standard deviations or less, which is significantly below levels seen in previous periods (in 2006 and 2008), when prices increased by three-standard deviations or more. One must also note that adjusted for inflation, the current gold prices are still lower than the 2011 high.

The outlook

Gold prices may continue to remain strong for more time.

IMF also holds a negative outlook on growth for 2020 and 2021. Weaker economies and weaker paper currencies will support gold prices. It makes sense for investors to add this metal to their portfolio, even at current prices. You can invest 10-15 per cent of your portfolio in gold any time for diversification purposes. Start moving small portions of your portfolio into the metal through gold ETFs or gold futures in regular intervals over the next six months. You can also consider investing through sovereign gold bonds.

Series V of the sovereign gold bond issue for 2020-21 is open now (till August 7); price is ₹5,334/gram. On your investment in the bond, the government will also pay an annual interest rate of 2.5 per cent. The interest earned is taxable; however, capital gains, if any at maturity will be tax-exempt.

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