A Strong Base for Gold

Posted On Thursday, Jun 17, 2010

With gold prices ruling near record highs, many are questioning the sustainability of these price levels . Let us try to figure out whether the price increases have been fundamental in nature or otherwise.

If you carefully analyse the current Bull Run in gold that started in 2001; there has been a peculiar pattern that it has followed. The pattern has been:

  1. An increase in prices from current levels
  2. Followed by a standard correction and
  3. Then a phase of consolidation.

After prices consolidate at a particular level, then a fresh upward move takes place.

Chart: Bull Run in Gold ($ per ounce)
QuantumMutualFund_Bull Run in Gold ($ per ounce)
Source: Bloomberg

Such pattern is nothing but an outcome of two divergent sets of buyers operating at different times. We identify this behavior as a "Two Hand Approach" leading to a steady and gradual price increases over the years. When prices rise higher, we have seen it accompanied by a lot of investors chasing gold as a safe haven on account of fears / uncertainties surrounding the global economy. When the prices correct and consolidate at lower levels, we have seen the traditional physical buying come in strongly and support prices. So, one hand i.e. traditional buyers supports prices at lower levels serving as a floor and the other hand investors take gold to another level higher as a reaction to changes in global economic conditions. (So on one hand you have traditional buyers of gold who will not allow it to fall below a certain level due to their purchases and on the other hand you have the investors taking the price even higher from that base level)Factors like rising deficits/ debts, currency debasement, inflationary prospects, etc act as catalysts for the investment demand leading to price increases.

Chart: Two Hand Approach (Demand in Tonnes)
Quantum Mutual Fund - Two Hand Approach (Demand in Tonnes)
Source: World Gold Council

This `two hand approach` is even now ensuring that the prices of gold move to higher levels. If you analyze demand patterns in 2010, the year saw good demand from physical consumption side in the first quarter following a correction. India and China saw stronger purchases as compared to the same period last year, despite prices being a lot higher. Post the first quarter, sovereign debt fears forced investors to safer assets like gold, thus increasing the demand and taking gold to another record high.

We believe this "two hand approach" would continue to take gold higher. Traditional buyers would continue to adjust to higher prices; thereby elevating the floor price of gold. Also, gold is clearly an under owned asset and as investors and central banks continue their shift to gold, this investment demand would help gold prices move even higher.

The Golden Myth

There is a myth that challenges the fundamental reasoning for rising gold prices. There is a belief that 150,000 tonnes of this precious metal is being hoarded and is capable of preventing gold prices from rising.

Such supplies have been in existence for a long time but still we have seen a fivefold increase in prices. If you carefully analyse the supply side situation, scarp supplies have significantly dried up compared to what we saw in the first quarter last year. Physical holders have burnt their fingers last year when they tried a trade off by selling their gold, assuming prices were at its peak, to buy back the new set of jewelry when prices fall. But the anticipated fall never came and they either lost what they held or had to buy back at higher prices. We have seen this happening in the first quarter last year, there was a queue of sellers in zaveri bazaar even ready to sell at steep discounts. This time around it’s not prevalent. Much higher prices will be now required to induce sellers to part away with their gold.

Also, central banks have been reluctant sellers. Central bank selling is almost nonexistent. Rather, on a net basis, central banks are showing signs of being net buyers.

Chart: Central bank and scrap sales drying up (in Tonnes)
Quantum Mutual Fund - Central bank and scrap sales drying up (in Tonnes)
Source: World Gold Council

So, the holders of gold aren’t ready to part away with their gold and on a net basis purchasing more of the existing production, how then would the hoard of gold affect or restrict gold’s prices from rising?

What makes gold prices really move?

The demand - supply scenario at best is able to shape prices in the short term and does not affect prices in the long term. However, it may induce actions from the stakeholders that may impact prices over the long term. For e.g.: continuous increase in prices may induce miners to invest more in exploration projects or induce buyers to consume less.

Widely viewed factors like exchange rates, interest rates, inflation etc also stimulate prices over the short to medium term but cannot explain their behaviour long term.

We believe that the long-term trends in the gold prices are driven by changes in the overall level of confidence in the monetary system and the economy. Therefore, gold needs to be seen as a monetary asset rather than a commodity. Given the current economic backdrop, where governments are laden with problems like rising deficits and unsustainable debts, it is indeed logical for gold prices to increase in value. Currencies are being continuously debased by policy makers. Gold is the only true monetary asset which cannot be printed by policy makers at will. Thus gold seems to be becoming some sort of a ‘replacement’ for fiat (paper) currencies across the globe.

This clearly explains why gold is rising in value and this upward trend will continue unless there is some rational decision making at the center of the global economy, which will again put some faith back into paper currencies.


The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments.

Investment Objective: Quantum Gold Fund’s (QGF) investment objective is to generate returns that are in line with the performance of gold and gold related instruments, subject to tracking errors. However, investment in gold related instruments will be made if and when SEBI permits mutual funds to invest in gold related instruments. The Scheme is designed to provide returns that before expenses, closely correspond to the returns provided by gold. Asset Allocation: QGF will primarily invest in physical gold and if allowed under SEBI Regulations, also in gold related securities including derivatives, and the scheme may invest in Money Market Instruments, short term corporate debt securities,CBLO and units of Debt and Liquid Schemes of Mutual Funds to meet liquidity needs. Terms of Issue: QGF is an open-ended Gold Exchange Traded Fund. Each unit of QGF will be approximately equal to the price of half (1/2) gram of Gold. Units will be issued at NAV based prices. On an ongoing basis direct purchases from the Fund would be restricted to only Authorised Participants and Eligible Investors. Units of QGF can be bought /sold like any other stock on the National Stock Exchange of India Ltd (NSE) or on any other stock exchanges where it is listed.   Entry Load: N.A. Exit Load: Nil in case of Authorised Participants; 0.5% in case of Eligible Investors. Risk Factors: All Mutual Funds and securities investments are subject to market risks including uncertainty of dividend distributions and the NAV of the schemes may go up or down depending upon the factors and forces affecting the gold and securities markets and there is no assurance or guarantee that the objectives of the scheme will be achieved. Quantum Gold Fund, is the name of the scheme and does not in any manner indicate either the quality of the Scheme, its future prospects or returns. Scheme Specific Risk: The QGF’s NAV will react to the Gold price movements. The Investor may lose money over short or long period due to fluctuation in Scheme’s NAV in response to factors such as economic and political developments, changes in interest rates and perceived trends in bullion prices, market movement and over longer periods during market downturns. Trading volumes, settlement periods and transfer procedures may restrict the liquidity of these investments of the QGF.  It is to be distinctly understood that the permission given by NSE should not in any way be deemed or construed that the Scheme Information Document for QGF has been cleared or approved by NSE nor does it certify the correctness or completeness of any of the contents of the said Scheme Information Document. The investors are advised to refer to the Scheme Information Document of QGF for full text of the ‘Disclaimer Clause of NSE’. Statutory Details: Quantum Mutual Fund (Fund) has been constituted as a Trust under the Indian Trusts Act, 1882.Sponsors: Quantum Advisors Private Limited. (Liability of Sponsor limited to Rs. 1,00,000/-)Trustee: Quantum Trustee Company Private Limited. Investment Manager: Quantum Asset Management Company Private Limited (AMC). The Sponsor, Trustee and the Investment Manager are incorporated under the Companies Act, 1956..The past performance of the Sponsor / AMC/ Fund has no bearing on the expected performance of the scheme. Mutual Funds investments are subject to market risks. Please read the Scheme Information Document(s) / Key Information Memorandum(s) / Statement of Additional Information / Addendums carefully before investing. Scheme Information Document(s) /Key Information Memorandum(s)/ Statement of Additional Information can be obtained at any of our Investor Service Centers or at the office of the AMC 505, Regent Chambers, 5th Floor, Nariman Point, Mumbai – 400 021 or on AMC website www.QuantumAMC.Com / www.QuantumMF.com

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