Gold Gold Gold

Indians were on a spending spree last year. But those who shopped for gold have reason to be satisfied with their purchase — gold price has seen a 26 per cent rally this year!

In rupee terms, gold prices have shot up by Rs 400/gram (Standard 24 carat gold), a 22 per cent run up. In contrast, stocks weren't a better play — the benchmark Sensex is up just 15 per cent year-to-date.



There are many reasons for gold's outperformance this year. One, the change in the gold-dollar relationship. While investors have traditionally bought gold when the dollar weakened, this year was different.

They bought the dollar and gold simultaneously as the euro weakened. Two, strong revival in jewellery demand after the recession induced dip last year.

Three, growing investment demand for the metal from emerging and also developed nations as returns from other options dwindled.

Further, gold fundamentals were supported by the lack of significant increase in mine outputs during the year and a fall in scrap gold sales.

Another interesting sidelight here is that India's jewellery consumption is growing at a fast pace and becoming a major demand driver for gold globally when most other Asian countries as also the US are showing a dip in jewellery consumption.

Many buyers for gold

With global economies still in the grip of uncertainty, gold continues to present a case for investment.

The series of down-grades on euro zone countries' debt and rising concerns over the European countries after Ireland's bailout, worked against the euro this year.

The pressure on euro augured well for the dollar which was itself grappling with issues of monetary easing by the Federal Reserve and inflation worries.

The dollar index which measures the value of the dollar against a basket of six currencies including the Euro has risen 4 per cent for the year.

Gold, which has always held an inverse relationship with dollar, has this year moved along with dollar. Euro's value against dollar has fallen by around 8 per cent since last year (from $1.43 to $1.31).

The demand for gold has been traditionally driven by jewellery consumption.

But that seems to be changing with investment demand for gold now driven by a range of products such as Gold Exchange Traded Funds.

Sample these numbers: Five years ago, in 2005, of the total demand for gold, 73 per cent was jewellery consumption and 16 per cent investment demand (including bars, coins and ETFs).

Today investment demand makes up 37 per cent of the metal's total consumption while jewellery makes up only 52 per cent. ETF (exchange traded fund) as a separate class within the identifiable investment category constitutes 12 per cent of the total gold consumption now.

The US SPDR Gold trust, the world's largest gold backed exchange traded fund has seen its holdings multiply fourfold from 2005.

In the last one year alone, the fund has added 164.4 tonnes of gold to its holdings. Gold buying by Central banks of nations was one of the factors that kept investor sentiment upbeat this year.

ETFs apart, China is emerging as a large consumer of gold as it expands its gold buying options for domestic buyers.

The country's regulatory authority has given its domestic mutual funds a nod to invest in gold ETFs outside China.

Also, there are reports that the Industrial and Commercial Bank of China has launched a gold accumulation plan for investors in mainland China with very low daily payments paving way for small investors to invest in gold.

Weak supply-side

The total supply of gold in the first nine months of the year (2993 tonnes) stood lower by three per cent despite a five per cent increase in mine output.

The key reason for this is the lower scrap sales. Supply from old scrap gold dropped by 3 per cent in the year.

It looks like the steadily rising gold prices have prompted people to refrain from scrap sales.

Supplies of gold from the central bank selling too waned in the year as the IMF has concluded its gold sale (403.3 tonnes) program that started in September 2009 and central banks held on to gold as a diversifier.

Will it offer some price support to gold? Can't say but it is certainly a sentiment booster.

Gold supply in the market has always been neck-to-neck with demand. 2009 was an unusual year when gold demand dropped (following a dip in jewellery sales) even as supplies stood considerably higher.

In 2010 there was a comeback again with demand at 2818.5 tonnes for the first nine months of the year while supply stood at 2993 tonnes, just sufficient for meeting demand requirements.

Which form of investment?

Gold has been the unparalleled winner for the year; surpassing all equity and debt funds in returns.

The MSCI World index is higher by 9 per cent this year and that is sharply lower to the gold price return of 26 per cent.

The emerging markets including India have given a return averaging 14 per cent only (year-to-date).

Indian investors however couldn't take full advantage of the gold price rally as rupee's appreciation (against dollar from Rs 46.53 last year to Rs 45.1 now) capped their returns.

Gold ETF (to include GoldBeES and similar products) investors have made a return of around 21 per cent.

Investments in physical gold have given a notch higher return of 22 per cent for the year.

Conversely, it is neither gold bars nor the ETFs but the global gold funds that have given investors the highest return on investment this year.

Gold mining stocks

Fund-of-fund schemes of DSP Blackrock World Gold fund and AIG World Gold fund that invested in stocks of gold and other precious metal mining companies, have given a good 27-29 per cent appreciation in NAV to their fund holders.

A higher return compared to even physical gold follows two reasons — one, expectations of higher profit for gold miners on improved realisation (with the rise in gold price) and two, the re-rating that started post the merger and acquisition deals in the industry that added to reserves of the players.

The merger of Newcrest Mining-Lihir Gold, Kinross Gold-Red Back Mining and Gold Corp's acquisition of Andean Resources are few big deals to name.

With some of these deals happening quite recently, there may be potential for further value unlocking in gold stocks. But before you choose mining funds over plainer options like gold ETFs do note that they are high risk bets — they are more volatile than gold and also tend to underperform physical gold during a downturn.

While most of the arguments presented here may well hold good in the coming year too, possible increases in interest rates that will make bond yields attractive, are a risk.