Gold 2009: A Larger Allocation

For the world's hungriest gold buyers, the metal has risen in price for 11 years running...

AMID THE ECONOMIC TURMOIL of 2008, gold and government bonds emerged as the clear winners for investors, notes Commodity Online from Mumbai.

In US Dollar terms, the Gold Price rose for the eighth consecutive year, rising 5% in 2008. For the Indian investor, gold has provided positive returns for 11 years running, with gains of 29% in 2008 according to analysis from India's Quantum Gold Fund.

Gold Investment has proved year-over-year that this under-owned asset class surely deserves a place in each investor’s portfolio, the Quantum Gold Fund says.

Look back to early 2008, gold rallied to an all-time record high above $1,000 an ounce for US buyers. This rally in gold was driven by multi-factors – including inflation fears as oil and other commodity prices escalated towards record highs, plus geopolitical concerns, and – biggest of all – the unfolding sub-prime debacle in the US investment banks, led by Bear Stearns collapsing.

That led to economic and financial upheaval, and this encouraged "safe haven" Gold Buying.

As events unfolded, the metal's price displayed ever-more volatility. Technically driven sell calls and profit booking then led to a sharp correction in gold. However, the correction was short-lived, as growing fears of systemic risk in the financial sector – along with rising inflationary expectations, dollar weakness and heightened geopolitical tensions – helped gold inch higher again in 2008.

One-by-one, mega financial institutions found it difficult to survive. Stock markets collapsed globally, and interbank lending froze – a perfect recipe for a financial disaster. Investors rushed for the cover of traditional safe-haven assets like government bonds and gold.

But even with this safe haven demand and heightened uncertainty, it caught many by surprise that Gold Prices could not surpass the previous highs reached in March '08. This led to questions being raised about gold's "safe haven" status.

The fundamental question remains today: Why did gold decline even when all the positive factors for a gold rally were in place?

First, a financial tsunami does not differentiate between good and bad assets; it takes away everything with it. As global assets plummeted last year, Gold Bullion – as an "asset of last resort" – was sold to meet margin calls due to heavy losses on other investments. Heavy hedge fund selling in order to meet redemption pressures also led to the decline.

Worldwide recession fears then led to an unwinding of commodity index investments, which included gold, and this led to more selling. A strong appreciation of the US Dollar as it gained ground when the crisis showed signs of spreading globally also triggered an unwinding of long-gold / short-dollar trades. This led to more outflows from gold.

All this clearly explains gold's apparently "weak" performance during such uncertain times. Investors hungry for liquidity sold gold, as it was the only asset doing well!

As the selling pressure eased, however, gold prices jumped on the back of strong physical offtake. Investors, in order to safeguard their wealth, increasingly turned towards gold –leading to physical supply shortages in key consuming areas. And so, albeit with increased volatility, gold kept inching higher.

Gold prices ended last year with positive returns for almost all investors worldwide, and at a time when other assets were badly hit. That underpinned gold's role as an effective portfolio diversifier.

Going forward, Gold in 2009 is expected to continue its upward journey. The macro economic and supply demand factors are supportive of higher prices. The uncertainty that surrounds the global economy should continue to underpin gold's role as a safe haven. And there is an increasing likelihood that the current global deflationary scenario could change to an inflationary one as central banks pump in money created out of thin air.

Geopolitical concerns have only recently been sidelined and are not over yet. There are various issues in different corners of the globe, such as the Israeli-Hamas conflict, the Indian-Pakistan war on terror, and Iran's nuclear imbroglio. Any of these might flare up and lead to increased tensions. Historically, gold has worked as an effective hedge against rising inflation and geopolitical concerns.

The financial crisis has been deeply rooted in the United States, and its central bank has been front-runner in pumping out money to rescue financial institutions and banks in order to help its economy back onto its feet. This increased money supply – without any real asset backing it – could eventually lead to debasement of the Dollar.

The Dollar may now continue to depreciate, as it has since the start of this decade, and help Gold Prices increase. Why? Because Gold and the Dollar tend to move in opposite directions to each other over the long term.

On the fundamental side, meanwhile, supply and demand factors continue to indicate a tight market in gold. Demand has been continuously rising, whereas supply just hasn't kept pace – even with prices quadrupling.

"Keep on Buying Gold as a hedge," Quantum Gold Fund advises Indian investors, "just in case your call on traditional asset classes like equities goes wrong.

"Gold will continue to minimize your losses as it has done in the past several years, including 2008. Also, the macro economic and supply demand fundamental factors are supportive of higher prices. Hence, investors can have a higher allocation to Gold."