Gold Update on 10 Oct 2009

Q. How do you see Gold prices panning out in near future?
• Gloomy US dollar outlook
Gold is traded in US dollar term but major consumption of gold is outside
US. Hence weakening US dollars makes gold cheaper for Non- US
investors and thereby increases demand for gold.
• Higher inflation expectation
Regulators have pumped in huge amount of liquidity to avert recessions.
During the political meeting held in London recently it was restated that G-
20 countries intend to maintain loose money policies unit economies
recover clearly. The rising inflation expectation benefits gold as gold is
seen as a good hedge against inflation.
• Increase in investment demand
Gold has limited stastistical correlation with any of the assets classes as
factors driving gold prices are different from factors driving other markets.
Hence gold acts as an excellent portfolio diversifier.The average share of
gold in global portfolios is quite low and given the present fundamental
setup it is undoubtedly going to go up, leading to higher gold demand.
Again gold prices have exhibited astonishing performance during recent
financial turmoil and that has managed to attract lot of investor’s attention.
Such investors are investing in gold by way of exchange traded products
and physical gold bars and coins.
• Central banks buying activity
We have seen Central banks diversifying away from US dollar and
increasing its share of gold reserves to safeguard against depreciating
dollar. China has announced that it has increase its gold reserves by
around 75 per cent, since 2003 and now holds around 1054 tones of gold
reserves but gold reserves still account for less than 2 percent of its
overall reserves. China is expected to continue increasing its reserves and
similar action is expected from other countries with high forex reserves
and that will result in higher gold prices.
The longer term outlook for gold prices seems extremely positive because of the
above mentioned reasons.
Q. The Chinese government has started accumulating Gold on a large scale
and has also been encouraging its people to do so which seems to be a
move of the government to strengthen its currency in the international
market vis-à-vis dollar. How will all this impact gold prices?
Though Chinese government has started accumulating gold they hold less than
2% of its total foreign reserves in Gold. Many experts believe they should hold
somewhere between 5% to 10% of its reserve in gold. If they intend to increase
gold reserves to such levels then they can eat away few years of mine supply
and that should be extremely bullish for gold prices.
It is widely believed that dollar is likely to depreciate in coming years and if US
dollar depreciates as predicated it will deplete countries Forex reserves. Ideally
central banks should diversify and increase its holding in other strong currencies.
But in absence of any strong alternative currency, gold benefits the most as it
acts as a good alternative to currencies. .
Hence if Chinese government is accumulating gold and encouraging its people
to do the same., such pragmatic notion will increase gold demand and benefit
gold prices.
Q. Despite the general prevalent belief that mining stocks run ahead of gold
prices why has Reliance come up with Gold ETF instead of gold fund which
invest in global mining stocks?
Major differences between gold mining stocks and physical gold /gold ETFs are.
• Gold mining stocks move along with equity markets and are adversely
impacted by financial crises and other factors affecting equity markets.
However fundamentals affecting gold prices are totally different from the
factors affecting other financial markets. Hence gold tends to act as an
excellent portfolio diversifier but gold mining stock may not.
• Gold mining companies can be negatively impacted by environmental
issues, labor related issues, political issues in mining countries and issues
relating to mining licenses. However any such issues with mining
companies are likely to be benefit gold prices as that would deter gold
supply.
• Expense ratio: ETFs have lower expense ratio compared to other gold
schemes.
• Investing in Gold ETFs reduces company specific risk. Management can
greatly influence the gold mining company outlook. Again many
companies need to hedge their sales to avail finance and hence will not
get the full benefit of higher gold prices.
• Generally the volatility is higher among prices of gold mining shares then
on gold prices. And hence its skews the risk adjusted returns in favor of
physical gold.
Because of the above mentioned reason it makes more sense for investors to
invest in gold ETFs than in gold mining companies and hence Reliance Mutual
Fund has come up with Gold ETF instead of gold fund.
Q. Apart from US dollar and demand - supply scenario, which other factors
according to you could possibly have a significant influence on the gold
prices?
As discussed above the higher inflation expectation, increase in investment
demand and central banks activity are likely to influence gold prices.
Q. India is the largest gold consumer. Indian consumer being price
sensitive how do you expect the Indian customer to behave in relation to
the rise in gold prices in terms of further buying or selling off of gold?
India is the largest gold consumer since ages. Indian consumers are very pries
sensitive. However a paradigm shift is required in weighing the fundamentals that
drive gold prices. Till recently, Jewellery demand use to be main determinant of
gold prices. However, despite weak jewellery demand over the last few quarters,
gold prices have performed well on the back of strong investment demand. Again
lot of jewellery demand remains uncatered as buyers were expecting a major
prices correction, which never actually materialized. Such uncatered jewellery
demand should cap the downside for gold prices and investment demand is
expected to be main factor influencing gold prices at higher levels.
Q. What is your view on Gold as an important asset class vis-à-vis equity?
What sort of asset allocation would you recommend between equity and
Gold?
Gold should be looked upon as a portfolio diversifier as gold does not have
statically significant correlation with any other assets class. Factors affecting gold
prices are different from factors affecting other asset classes. Hence including
gold in one’s portfolio should stabilize portfolio returns and give better risk
adjusted returns. Ideally a portfolio should have 5 to 10 % of its investment in
gold.
To sum it up, we are convinced that over a period of time Gold Etfs will become
more popular with the Indian investors as an asset class and not merely as a
portfolio diversifier.