Gold lost lure as investor demand for risk assets remained high

Mumbai-India (Dec 27)  It has been a lost year for gold. Globally, investors have remained risk takers both in fixed income and equity markets. Domestic equity markets have delivered at least 27% since the start of 2017 and even though fixed income returns turned lower this year—change in global gold prices, a rise of around 2%, is dismal and has kept investors away.

Overall demand for gold is lower. Both jewellery and investment demand is lower globally, despite a pick-up in global demand for gold exchange traded funds (ETFs).

Here is a quick recap of what impacted gold demand and prices the most. 

Indian demand made the difference

The biggest disruptor for overall gold demand has been the demand shortfall in India, which till 2011 used to be the largest consumer of gold. Since then, China has taken over and Indian demand has shrunk each year. The big change came last year in 2016 when Indian demand fell to 666 tonnes from 857 tonnes in 2015, according to data from the World Gold Council; a fall of 22%. This year too seems like a slow one for demand in India, with the first three quarters’ demand coming in at 454 tonnes.

According to R. Sivakumar, head-fixed income, Axis Asset Management Co. Ltd: “This is not a new trend. Domestic investor interest in gold has slowed over the last two-three years as real returns from financial assets have been positive. There is no need to look towards gold or other physical assets to hedge against inflation. The longer-term trend in gold demand is also linked to risk. If there is significant risk that can cause other assets to underperform, there is a rationale to shift.”

Last year, the declining trend for global gold ETF demand turned positive. While this segment looked like it could drive broader interest in gold, and provide stability to prices, so far this year the ETF demand is positive but much lower than what was seen in the first three quarters of 2016.

Sudheesh Nambiath, a senior analyst with GFMS, a division of Thomson Reuters, said, “Global buying picked up on the back of low prices that are seen to be at a turning point. It is generally viewed that the number of interest rate hikes is limited, lending a positive bias to gold investments.”

In India though, the trend in gold ETF demand seems to be the opposite especially after demonetization. Once all the cash got into the official system as a result of demonetization, the segment that led gold demand with unaccounted money shrank in size.

Investors have also actively exited domestic gold ETFs with assets under management for this category falling by around Rs500 crore this year. On the other hand, the Gold Bond Scheme introduced by the government is seeing a fair number of investors. The price of this bond is linked to gold price and does not require actual reserves of gold to be maintained against the bond.

Investors taking risks in markets

As equity markets across the globe continued to rise, demand for a gold investment as a hedge remained subdued. Moreover, with the US Federal Reserve indicating that rate hikes may yet be seen, yields could rise further, once again negating any incremental investment demand for gold.

Nambiath says, “We are positive on prices rising from current levels to around $1,400 per ounce. There is an increased level of risk in global capital markets, which is not yet being discounted into gold prices. If any major event triggers a sell-off in capital markets, gold can benefit.”

As of now, despite asset prices being on a rising trend for some time, investors aren’t rushing to the safety of gold. One reason could be the low consumer inflation worldwide, accompanied by stable currencies. Another reason could be the low interest rates and unencumbered leverage that is available for trading.

In India, the regulatory controls have curbed demand and to that extent price rise is impacted too. According to the Demand Trend report from World Gold Council for Q3 2017, demand remained under pressure thanks to two major events. First, the application of Goods and Services Tax on gold purchases: the process around this new tax format remained cumbersome for traders. Second, under the Prevention of Money Laundering Act, the government made it mandatory to have Know Your Customer compliance by jewellers for purchases beyond Rs50,000. Both these events led to a 24% drop in domestic gold demand for the third quarter of 2017.

As of now, the outlook for gold demand and prices remains low with no triggers seen on horizon for a reversal of trend. Experts suggest there could be a brief shift if geo-political tensions escalate or the leveraged capital markets break down. These factors may be the reasons why buying from Central Banks across the world has risen nearly 7% so far this year.

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