Gold prices to fall further over next 5-7 yrs: Morningstar

There are three things investors need to remember when they decide whether to hold gold in their portfolios. First is that over the long-term gold has been a reliable store of value and has kept its purchasing power and so, you could buy the same quantity of goods with gold now which you could 50-200 years ago. People tend to hold gold like an insurance against inflation.

The second thing is that when you buy gold in India what you are really doing is buying a US dollar asset. Gold is priced in US dollar which indicates that as an Indian investor you are getting exposed to the USD.

You are getting some currency diversification and that is quite important because it is hard for Indians to invest a significant part of their portfolio overseas.

And the third point is that although gold is not an asset that provides income and therefore, it is hard to value it. It does have that relationship with inflation, so inflation has a gravitational pull and when price of gold gets very far away from inflation rate it tends to fall.

In 1980 when gold price picked in real terms it then spent the next 10-15 years falling and when it reached a low it was about 50-60 percent below inflation rate in the late 90s and then rose steadily.

If you look at that and ask how does that look right now? Is gold above where it should be or is it below where it should be? Well, it is above where it should be even though the price is falling.

We look at it very simply. We go back to when the US came off Bretton Woods arrangement with relation to gold when it became possible for everybody to buy gold and trade gold which is by 1974. If you track the price of gold compared to the inflation rate over that time it has been quite reliable.

On a 7-10 years basis, when you get very big deviations in that relationship it tells you something useful about the future of gold. But about two years ago gold was about 126 percent above where the inflation index would have been and that is about the same as the peak it reached in the early 1980s.

Q: Is it still above the inflation index?

A: Yes. It is about 14-15 percent above. It means that it still has some way to go to get back to that normal relationship. So right now you would hold a little less gold. But is your outlook on inflation in India and your outlook on US dollar India exchange rate are important components of deciding how much to have in gold.

Q: Do you think gold has the chance of getting into triple digits as well sub-thousand price, maybe by next year?

A: We forecast short-term movement and there is an element of randomness about how exactly different components of the market behave. If you want to look at short-term movements, they are typically explained by a simple demand supply analysis which is on the demand side you have jewellery which is fairly constant.

I am not talking global demand here. You have a demand for gold bars and gold coins. You have investment demand which is really ETFs on top of that gold bars and coins and then you have the central banks.

On the supply side you have mine production and then you have the recycled gold that people sell. There is enough additional production from mines to satisfy jewellery demand each year.

Mine production adds around 1.5 to 2 percent total supply of gold each year and so, the swing factor tends to be people’s perception about gold as an investment. This has swung from being a positive in 2012 with ETFs adding to demand to being a negative as they sold.

This gold is going for further slowdown as people still have significant component of the gold that they purchased 5-10 years ago. And the risk of them to divest that as they have become a bit pessimistic about the outlook and are seeing losses.

Q: You said that even at the moment gold is 14-15 percent above its long range inflation index. How much lower has it gone in the past?

A: Just a bit to be clear on that it is 40-50 percent. The way we think about this is the inflation relationship between gold and inflation is lack of a form of gravity. You need to get quite far away from inflation level before it really starts to have an impact and you have kind of come of the highs, you are still sufficiently far away that you get pulled down again. But in the short-term anything is possible.

It would be quite possible for us to have a surprise with inflation on the upside and for gold to go up again for a while or for it to go down.

I am not forecasting what gold is going to do over the next one year or even two years. Over the next 5-7 years I would expect the price of gold to be lower over that period than it is today.