YELLOW METAL: Gold price correction to push up retail demand

As we move into the final month of this eventful year, market sentiment is mixed as investors seem to be weighing the mounting virus case count against the optimism of vaccine breakthroughs. This has boosted risk assets and hurt gold prices which ended November 5.4% lower, at $1776/ounce. Gold prices seem stretched to the downside relative to the fundamentals as markets get carried away on the emergence of effective vaccines.

Risks persists
If you dig deeper, you will find that risks still persist. Efficacy, regulatory approval, large scale manufacturing, costs and distribution of the vaccines still need to be worked out. So realistically the vaccine isn’t coming to local pharmacies for the general public any time soon, while a second wave of the disease is already underway.

The pandemic induced economic damage has been severe. Therefore, expecting a full and immediate restoration of economic activity is naive. In fact, with a resurgence in cases in the United States and Europe, a complete reversal of the Great Lockdown has been further delayed, hurting the fragile recovery. The World Bank estimates that a full recovery will take up to five years. The global financial crisis, which was largely a financial crisis, also took seven years for full recovery. The COVID-19 crisis is much more severe in comparison.

Stock markets have never been as expensive as they are today. The Nifty 50 P/E ratio has jumped up from 28 at the start of 2020 to 35 as of November end and the S & P 500’s ratio has jumped up from 25 to 37. This is in spite of deteriorating fundamentals. These soaring valuations are a result of massive liquidity injections by central banks and investors ignoring near-term headwinds such as surging global Covid-19 infections, and instead looking ahead to 2021.

Gold’s role
An understanding of these risks and an appreciation for gold’s stabilising role in times of heightened risk and uncertainty, make holding gold an imperative for reducing portfolio risks. As evident, global policy makers are continuing to resort to the usual prescription of monetary inflation, credit expansion and government spending to tackle the economic fallout of the pandemic.

With the extent of damage inflicted by this pandemic, it is hard to imagine a scenario where governments and central banks will change course any time soon. The result will be currency debasement and years of low interest rates in order to service the debt.

Gold, which has potential to store value over long time periods and does well in times of low nominal and negative real interest rates, will thus continue to be a strategic element of investment portfolios, generating risk adjusted returns for the investor. Consumer demand for gold which has been weak this year because of the economic hardships brought about by Covid-19 is expected to recover going forward as consumers in India and China take advantage of the price correction. This will be a fillip for gold prices.

The writer is senior fund manager, Alternative Investments, Quantum Mutual Fund