The Stock Markets Golden Run

Posted On Thursday, Jul 30, 2009


With stock markets rising, should investors no longer buy gold?
Or if they own gold, should they sell gold - and put all their money in the stock markets?

Since March 9, 2009 the BSE-30 Index has surged by +79.22% and gold prices measured in US Dollars have increased by +3.99%.
However, because the Indian Rupee has gained +8.71% against the US Dollar, gold prices for an Indian investor have decreased by -5.04%.

Stock markets glitter, gold is dull.

May 29, 2009March 9, 2009% Gain
BSE - 30 Index14,625.258,160.40+79.22%
Gold in INR 1,580.941,501.23-5.04%
INR v/s USD 47.2951.80 +8.71%
Gold in USD972.00 934.75+3.99%

The price of gold in India is determined by 2 factors:

  1. the exchange rate between the INR and the USD, and

  2. the price of gold in the international markets which is priced in USD.

A strong Indian Rupee hurts your returns from gold in India

The Indian Rupee has gained against the US Dollar largely because foreign investors have bought over USD 5 billion worth of shares since March 9, 2009.

When a foreign investor buys shares, they have to pay for this in Indian Rupees.

What this means is that foreign investors take their US Dollars and give it to the RBI which then gives them Indian Rupees so that they can pay the brokers these INR for the shares they have bought on the stock market.

In the calendar year 2008, foreign investors sold shares worth USD 13 billion. That helped the Indian Rupee to fall by -20% last year.

Now the foreign buying of Indian shares is making the Indian Rupee stronger.

It would be safe to assume that the euphoria of the new government will keep the momentum of foreign buying of Indian shares and this will keep the INR strong.

So, if the INR is likely to gain another +10% and hurt your returns from investing in gold when measured in INR, why are we asking you to buy gold, a USD priced product?

Gold can surge by 50% to cross USD 1,500

The central banks all over the world are printing large amounts of money.

They are trying to rescue the global economy - and rightfully so.

But their act of printing money is causing huge potential inflationary pressures. This will cause a flight to different asset classes that are seen as a "store of value" in times of crises (when the banks were going bust globally) and in times of inflation (what could happen by the year 2010).

Gold, in our view, has risen from USD 600 in July 2007 to USD 900 levels in May 2009 because of the crises of confidence in the banking and financial system.

That was a 50% rise.

The next 50% rise may be from the USD 900 levels to USD 1,500 levels based on fears of inflation.

We are not definite that it will surge by 50%, but we are not definite about anything.
But it could.

The golden myth

With Indian Equities soaring, investors are debating whether they should maintain their allocations to gold or exit their investment in gold.

Answer is a resounding Yes... Maintain your allocations.
To put it simply, do you question your insurance when you return home safely? No right, then why do you question your portfolio insurance... Keep your insurance.

In the year 2008 when the BSE-30 Index tanked by -52%, gold was up by +30%.

Investors have a misguided belief that when equities perform well, gold would not do well. This is not so true. Gold and equity can increase together. Remember, the period from 2003 to 2007 when equities markets were in a bull run, gold prices increased along. During this period, the stock markets gained - and so did Gold (see Chart 1).

Gold and shares both rose (2003-2007)
Gold and shares both rose
*Gold prices are international gold prices converted to rupees using the INR rate - No taxes & duties included.
Source: Bloomberg

So, while it is true that investing in shares gave you a better return than investing in gold, both investments gave investors a positive return.

However, history says that usually when equities do not perform as per our expectations i.e. low or negative returns, gold tends to do well.

In summary:

  1. gold tends to do well when equities perform poorly, and

  2. when stock markets surge, gold tends to also give you returns but cannot match the returns you make from investing in stocks

The risk to gold prices

Investors are also worried that with gold prices hovering at higher levels above 14,000 per ten grams; is it a right time to enter or should wait to see if the price corrects?

While we are positive on gold, it is possible that gold may have a "correction" and bounce around the USD 800 to USD 900 levels - as it has done for much of the past 6 months.

While investment in gold amounts only 0.58% of all investment in all assets globally, we are concerned about the recent growth in some of the types of investors who own gold.

Gold as a % total assets
Gold as a % total assets
Source: World Gold Council

In the past 2 years, we are seeing unprecedented buying of gold from a new breed of investors. There have been unprecedented inflows into Gold ETFs (like Quantum Gold Fund), and there were episodes of shortages of smaller coins and bars on account of higher demand.
While this demonstrates that investors are increasingly turning to this safe haven metal, we need to understand who these "investors" are.  Long term investors during times of financial crisis and inflation were seen as the main buyers of gold until now. However, very recently, there has been a gold rush by so called "Hedge Funds".

Hedge funds are buying gold with a vengeance

As of March 31, 2009 about 20% of the SPDR Gold Trust ETF (the world’s biggest Gold ETF with xx million ounces of gold). Some of these hedge funds had also correctly betted on the sub prime and housing debacle in the USA - so obviously they are smart, and know what they are doing.

But we are nervous about hedge funds - generally short term pools of money that swing from one asset class to another in search of "absolute returns". The nature of this beast is that they are quick to enter and exit positions based on short term opportunities and, hence, are a cause of worry. They can swing the price of gold with their violent entry and exits. The reasons for their entry/exit are many. Are they creating positions to hedge against uncertain risks? Are they here to earn potential long term profits? Are they looking to earn from the longer term decline from currency devaluations or rapidly approaching inflation fear?

We don’t know - but their rapid exit may lead to a short term decline in gold prices.

It adds up to gold

Gold from a longer term perspective is a good investment, especially in the view of 2 extremes: a financial crises or high inflation. 
Diversification buys you protection: as we witnessed in the year 2008 when stock markets fell off the cliff and gold climbed to new peaks.

The choice is not stocks or gold: the answer is stocks and gold.

While there could be short term "noise" in the price of gold due to the strong Indian Rupee and the selling by hedge funds, you should view that as a chance to add to your ownership of Quantum Gold Fund.

Above article is authored by Quantum.

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