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Acche Din Spell Trouble for Gold

Recent returns suggest that gold - that ultimate safe haven -has lost its mojo, with gold ETFs being the worst performing funds of the last 1 year

Just a year ago, events such as the insurgency in Iraq with the possibility of US troops marching in would have been just the cue for gold to break new records. But global gold prices have been muted in their response to the recent Iraq skirmish.

After rising briefly to $1284/troy ounce, global prices slid back within a day without even breaching the $1300 mark. Gold holdings in SPDR Gold Trust - the world's largest gold exchange traded fund, actually fell after the event.

Isn't this proof enough that gold - that ultimate safe haven -has lost its mojo? Just look at the yellow metal's recent returns. At the start of 2013, gold exchange traded funds (ETFs) were the top fund category in the Value Research rankings with five-year returns of 30 per cent plus, beating equity, debt and everything else. In the last one year, Gold ETFs have been the worst performing investments with a loss of 1 per cent.

So how did gold go from being from top to bottom of the class? Three factors have contributed.

One, gold is the investment everyone flocks to in terrible times. That's why the recent bull-run in gold actually started in October 2008, just after the global credit crisis exploded. But with the global economy recovering from that crisis over the last two years, investors have grown more confident of 'acche din'. They have thus preferred to buy equities, bonds and other assets, deserting gold.

If the Indian Sensex is up by 30 per cent in the last one year, the US market is up 18 per cent, Japan has risen 13 per cent and European markets are higher by 18 per cent. This contrasts with gold's 8 per cent negative return in dollar terms.

Two, let's not forget the role that the famous US quantitative easing played in driving up global liquidity and causing mini-bubbles in many assets, including gold. With the Fed now withdrawing its QE at the rate of $10 billion each month, the excess money chasing gold has evaporated.

Finally, for Indian investors, the rupee's about-turn has alsodented gold price returns. As long as the rupee was taking a tumble in 2012-13, it propped up domestic gold pricesand added to returns from gold ETFs. Now a stronger rupee means that domestic gold prices are falling more than global prices.

What does all this mean for gold prices in the future? Is the fall a buying opportunity? Not really, if you're looking at double-digit returns.

The world over, investors love to chase assets that have given the most returns in the recent past. So after flocking to gold ETFs, bars and coins in the last five years as gold prices were rising, investors have been quick to sell gold and withdraw money from ETFs in the last one year. This trend is likely to continue as gold struggles. Data from the World Gold Council show that nearly 34 per cent of the global demand for gold in the last five years came from 'investors' and not jewellery buyers. With a third of 'demand' gone, expect weaker fundamentals for gold over the next two-three years.

Yes, as 'investors' flee from gold, the traditional jewellery buyers from countries such as India and China may still increase their purchases. But whether such buying will make up for the vanishing investment demand, is a moot question.

With demand shrinking, global gold fundamentals will be balanced only if gold miners cut back on their output. Such cutbacks may happen if global gold prices fall below costs, estimated at about $1100-1200/troy ounce and remain there for an extended period. This process, even if happens, is likely to take time. In the meantime, $1100-1200 may make a good floor price for gold. But in the absence of upside triggers, global gold returns may average no more than 5-6 per cent a year.

For Indians, the returns could be worse, if the rupee holds steady as it has done in recent times. The installation of a strong government at the Centre has been enough to bring in a flood of FII flows. If this trend continues and the rupee does not depreciate sharply, domestic returns from gold will be barely in line with that for global investors. The removal of artificial props such as the 10 per cent import duty on gold and the stringent import curbs, if the Centre considers it, will only add to domestic supply and further weaken prices.

But what if the Iraq crisis escalates, the rupee trips, the global economy takes a turn for the worse or a new war breaks out? Well, to shield your portfolio from such events, you can continue to allocate 5 per cent or so of your wealth to gold ETFs.

But don't forget that gold thrives on crisis. After hitting a record high of $850/ ounce during the Gulf oil crisis in 1980, it took 28 years for gold to again get back to that level during the Lehman crisis of 2008. So, if you believe the acche din are here to stay, gold is not the place to be.