Prospects of Gold As An Investment

By SiliconIndia   |   Monday, October 31, 2011
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Bangalore: Gold has been gaining prominence as an 'asset' with each passing day. The differentiating factor of gold being that it has a universal market - the size, depth and liquidity of the gold market surpasses that of equities, debt and practically all other asset classes. Gold price have risen by an astounding 180 percent in the last 4 years; according to CARE ratings it has risen up to 23 percent since January 2011 and has outperformed practically all know asset classes in the last decade. Factors for the rise in Price * The Demand from diverse quarters has attracted to various attributes associated with the metal namely: safe haven investment, hedge against inflation, the poor/ negative correlation with other asset classes, volatile stock markets, absence of default risk. * Loss of purchasing power of currencies with the increase in supply of the same as a consequence of the cheap money policy adopted by the developed countries following the financial crisis of 2008 in an attempt to boost economic growth there is another reason. * A spurt in central banks gold buying since 2009 after being net seller for over two decades has also contributed significantly to demand and thereby prices. Irrepressible Demand The year-on-year price increases have not dented gold demand. If at all markets have been seen to use the occasional dips in prices as buying opportunities. World gold demand grew on a year-on-year basis by nearly 11% to around 4000 tonnes in 2010 alone. India, the world's largest gold consumer, and China being the drivers of this demand, accounting for over 55 perent of global gold jewellery demand and 52% gold investment demand. India registered a 38% increase in consumer demand in 2010, despite prices surging by over 25% during the year. This year too, high domestic gold imports (35% increase in H12011) highlights the resilience of demand to high prices and inflation. In the last 1 year, gold has given returns to the tune of 24%, despite volatile price movements. Portfolio Diversification Tool Gold is fast proving to be an essential feature of portfolio diversification and a risk management tool for financial soundness. It has outclassed other investments classes, delivering the highest returns. It is considered as an insurance for financial assets. The risk-adjusted-return of a portfolio having gold has been found to be higher(0.73) than those that do not have gold(0.55. Investors are known to cover for the losses made in other markets/assets by liquidating their profitable positions in gold. Direction of prices Although the recent weeks saw interruptions in the long term price rally of gold, the prospects for the metal for the medium to long term continue to be encouraging. In an attempt to forecast gold prices based on past trends of the dollar exchange rates, a regression analysis of gold prices and the dollar exchange rate including a trend variable (time) was done for the period 2004 to 2009. The regression equation derived was: Gold Prices= 0.84-0.67USD/Euro+0.014Trend Fundamental factors that are influencing prices * With macro-economic uncertainties impairing the risk taking capacity of investors, gold's stand to gain as a preferred investment. Gold imports on the rise in key markets that could give a boost to prices. * China's central bank demand for gold is stated to increase from the current 1100 tonnes to 6000 tonnes. * Weak stock markets and high inflation that have negative impact on bank deposits would push investors to gold. * The weak trend in the value of the US dollar is likely to persist, in turn spurring demand for gold and thereby prices. * The gold ETF holdings did not see much liquidation in the recent rout, highlighting the investor expectations of prospects for gold.
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