After rallying strongly for close to two years when its price in the international markets jumped by nearly 60 percent (between July 2018 and August 2020), gold has seen a sharp correction. The yellow metal is down nearly 15 percent from its August 2020 peak in US dollars.
This has raised doubt about the future of gold investing as the pullback was accompanied by a rally in competing assets such as equity, bitcoins, commodities and even real estate.
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The yield on 10-year US government bonds is up nearly 100 basis points since its lows in July last year. One basis point is one-hundredth of a percent. As gold is a no-yield asset, higher interest rate or bond yields make it less attractive for investors to hold gold.
Most analysts expect a further rise in bond yields in the US as retail inflation goes up, boosted by successive fiscal stimulus by the Federal government. This could weigh on gold prices in the international market in the near to mid-term.
Also Read: Inflation is coming. Five tips to prepare for it.
India is not USA
Indian economy however faces a slightly different dynamic.
This is a perfect recipe for higher gold prices in the Indian market even if the yellow metal either stays stable in the international market or sees only a small rise from the current levels.
We can already see it playing out. According to the Reserve Bank of India, gold prices (annual average) were up around 32 percent in FY21 in the Mumbai market, rising faster than the 24.7 percent rally in gold prices at the London Metal Exchange.
This additional returns for gold investors in India is attributed to the higher inflation in India compared to the developed markets.
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Most experts believe this premium or additional returns in rupee will stay and even expand further as inflation gathers pace in the coming months and quarters. This makes gold an excellent investment for Indian investors at the current level.
In Mumbai 24 Carat gold is currently trading at around Rs 49,000 per 10 gm. This is nearly 15 percent lower than the intraday high of around Rs 59,000/10 gm reached in August but up nearly 7 percent higher than its 52-week low of 45,900/10 gm. Even in the international market gold is up nearly 7 percent from its 52-week low reached last month.
In the long-term, the biggest draw of gold for investors and savers in India is its ability to provide a better hedge against inflation and currency depreciation than equity or other competing asset classes.
Also Read: How investment in gold can protect you from inflation and rupee depreciation
For example, in the last 10 years, the gold prices in India have appreciated at a compounded annual rate of 9.8 percent against 8.4 percent CAGR rise in the BSE Sensex during the period. In the same period, Indian rupee has lost its value against the US dollar at an annualised rate of 5 percent while annual consumer inflation has been around 6.7 percent on average. In the same period, gold prices in the international market rose at an annualised rate of 3.5 percent.
All the numbers are annual averages to iron out short-term fluctuations. So, if history is any guide, gold not only hedges your portfolio and wealth against inflation and currency depreciation but also gives a small premium.
Many analysts also believe that it’s a matter of time before gold starts rallying in the international market as well despite the risk of higher bond yields. This is because the central banks cannot afford higher interest given the record level of public debt in most major economies including India and the USA.
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This sets-up a battle between bondholders who will ask for higher yields and central banks which will push for lower yields. Given this the only way higher yields will be justified is if there is inflation and currency depreciation. This will allow governments to inflate their huge debt. This could however translate into negative real yields or interest rate which is good for gold prices.
Gold also looks oversold when compared with continued rally in equity and commodities especially industrial metals.
(Karan Deo Sharma is a Mumbai-based finance and equity markets specialist).
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