Even as equities and bonds remain weak, gold has rallied by nearly 50 per cent in the last 18 months. As yet another tranche of sovereign gold bonds (SGBs) becomes available for subscription, it is important to understand the dynamics of gold prices.
Mining production
Gold mining activities were impacted in the first quarter of CY-2020 due to the ongoing COVID-induced lockdowns across the world. Mining production fell 3 per cent year-on-year in the first quarter, the lowest since 2015, as per data from the World Gold Council. As supply remains constrained, prices are expected to head higher, especially as mining activity still remains weak.
Central Banks and gold
Gold is held by central banks as a part of their reserves.
If trade wars worsen and if the central bankers want to further diversify away from the US dollar, the demand for gold may go up, thus pushing up prices.
Jewellery demand
China and India account for more than half of the global demand for gold, mostly for making jewellery. Rising gold prices and the lockdown ensured that gold demand fell 65 per cent (China) and 41 per cent (India) in the first quarter. Global demand declined 39 per cent. When gold prices rise quickly, jewellery buyers may take time to adjust with the new normal.
Investment demand
Investors consider gold as a safe haven. Exchange traded funds backed by gold added 170 tonnes in April 2020 – a five per cent growth in value terms, according to World Gold Council.
Gold ETF assets have grown over 80 per cent over the past one year.
Bars and Coins also may be in demand as investment avenues. Due to operations of gold refiners being hit in Switzerland, there has been limited supply of refined bars and coins.
Exchange rate
Since gold is priced in US dollars and we import all our requirement, exchange rates play a key role in pricing. A weak rupee can add to the price of gold.
Despite being a safe haven and having rallied spectacularly in the last year-and-a-half, investors must not rush to increase their gold exposure.
Investors would be better off focusing on their asset allocation than chasing returns.
Don’t allocate more than 10-15 per cent of your portfolio to gold. SGBs and gold ETFs are good vehicles to take exposure.
Producer hedging
Miners tend to sell their gold production in the futures markets to hedge themselves in case of a fall in price. This is termed as producer hedging. If producer hedging rises, prices naturally drop. Gold miners may chose not to hedge all their output and even reverse their hedged positions (de-hedge in industry parlance) by buying back the futures contracts sold in the past, if they expect prices to head higher.
Scrap Sales
Gold is sold or pledged to raise cash. Job losses across the world and recycled gold or scrap sale are expected to go up.
Due to the lockdown, large markets such as India have not seen scrap gold sales so far, as jewellery retailers remain shut and banks are not allowed to buy bullion back. But the situation may change after the lockdown ends. Increased scrap sales may push prices lower.
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