The binge may end soon

GOLD PRICES ARE GREAT for sellers, not buyers. Given the high prices of the past 18 months, experts advise buyers to wait. They say the price of the yellow metal—around Rs 20,450 per 10 grams in Mumbai’s bullion market, up 20% from a year ago—is clearly unsustainable. According to data from the World Gold Council (WGC), India and China are leading the current gold bubble, accounting for 30% and 18% respectively of the global gold demand during the 12 months up to September 2010. Besides these two countries, the other major market to witness a growth in volumes was Thailand, where gold purchases shot up about 10-fold to 77.7 tonnes as people stocked up in the wake of political turmoil.

Last year, India extended its lead as the world’s largest market for gold, with consumers and investors buying about 855 tonnes between October 2009 and September 2010, up 65% on a year-on-year basis.

According to WGC figures, gold accounted for 10% of India’s household savings between September 2009 and September 2010. In the previous 10 years, the ratio was a little more than 4% on average, including silver and other valuables. This points to an imbalance and the increase may not be sustainable next year.

If other economies fail to pick up the slack in demand, this may weigh heavy on prices next year. “We are not bullish on gold and are advising long-term investors to stay away from it. We expect gold prices to drop by as much as 20% in next few months to settle at around Rs 17,800 per 10 grams,” says Kishore Narne, head of commodities at Anand Rathi Financial Services.

According to him, inflationary trends and macroeconomic volatility were being overestimated and the worst is now behind us. “This will result in traditional assets such as equities and bonds doing much better next year, which will pull money away from gold and thus bring down its price.”

A repeat of the 2008 gold price crash may be in the offing. That year, after rising by as much as 50% in less than a year, prices fell by 25% beginning March 2008. The bulls, however, argue that we are not yet done with macroeconomic uncertainty and that the recipe is right for a further rally in gold prices. “Gold is a hedge against inflation and economic uncertainty, and the global economy still faces headwinds. There are issues such as the European sovereign debt crisis that need to be resolved,” says Swati Kulkarni, vice president and fund manager at UTI Mutual Fund. UTI manages the country’s second largest gold exchange traded fund (ETF) with assets of around Rs 530 crore under management.

Jewellers concur with Kulkarni and foresee a strong demand for gold, given Indians’ fascination with gold jewellery. “Purchases in India are driven by family events such as marriages. Women come to buy with a budget in mind and gold prices play only a minor role in their decision,” says Sandeep Kulhari, vice president, retail, Tanishq, the jewellery division of Titan Industries.

Kulkarni’s confidence is partly based on the fact that gold has been one the best-performing assets in 2010, with year-to-date returns of around 20%. This is in line with the appreciation in the broader market during the period and much superior to the roughly 15% returns from a typical diversified equity mutual fund.

According to another school of thought, the near-term blip in gold prices is not a big deal. “Gold has proven itself as a hedge against volatility in other asset classes. So we propose to investors that they allocate at least 10% to 20% of their entire portfolio to this asset, irrespective of the market conditions,” says Rajan Mehta, executive director of Benchmark Mutual Fund. The fund house’s gold ETF is India’s largest, with assets under management of about Rs 1,300 crore.

There is some merit in Mehta’s argument, but how much more gold can Indians binge on? The country’s incremental gold demand of around 336 tonnes was more than one-and-a-half times the global incremental demand of around 207 tonnes during the 12 months ending September 2010. Unless there is a dramatic increase in household savings this year, this demand cannot hold up. At the global level, retail investment and ETFs together account for about 35% of the total demand for the yellow metal. Any perceived weakness in gold prices may trigger a sell-off by investors. That’s likely to be a good time to buy.