Expect gold to fall to Rs 23000-24000; US rate hike will trigger next spike

Last Updated: Mon, Sep 07, 2015 18:33 hrs

Gold prices have crashed and questions are being raised now, on its ability to give potential returns in the future. The recent fall was more or less a writing on the wall. Gold has failed to do well recently, even as global financial markets were roiled by the plunge in China's stock markets and the Greece crisis. The yellow metal is seen as a safe haven in times of economic and geo-political uncertainties.

The trigger this time was a little different.

It was the Chinese market participants selling gold, as opposed to buying them on dips, that tipped the scales against gold. Even gold's share in China's central bank reserve basket has come down.

It was China, which overtook India as the largest buyer of gold the previous year. After buying a relatively meager 454 tonnes in the six years to 2009, as China's economy raced ahead, the People's Bank of China's bullion buying was expected to accelerate as it spread risk away from its trillions of US dollars invested mostly in US treasuries.

But as China's foreign exchange reserves expanded far quicker than its gold reserves, the share of gold fell to 1.65 percent, down from 1.85 percent before - far below market expectations.

Markets were ideally expecting China's central bank gold reserves to be in the range of 10-15%. Although, it is perceived as negative, I see this as a possible hope for bullion demand revival.

Though, it indicates weakness, there is scope for China to add to its reserves as prices have fallen almost 40% from its peak of $1920. China could move into gold again due to problems posed by rates rising in the US treasury market.

Due to a lack of liquidity in the US treasury markets, I expect that gold, which is still the most liquid asset class, will be the beneficiary of this development. China could take the lead in being the largest producer and consumer of gold, dictating the direction of gold prices, which is presently being set by some western banks.

There is a paradigm shift in the way the world views commodities presently. It was the US few decades ago that was consuming various commodities which was mostly produced outside their soil. Due to active interest in future markets, prices were being set in US exchanges in the name of hedging and price discovery.

Now, it is China's turn to take the lead and that is precisely what happened last week when Chinese investors offloaded large quantities of the precious metal. After lifting a ban on bullion trading and opening the Shanghai Gold Exchange in 2002, the bourse is now the largest physical bullion marketplace.

The biggest factor that has been pressuring gold prices is the possible rise in interest rates in the US. Recent strengthening of the US economy and expected interest rate hike by the US Federal Reserve are likely to strengthen the US dollar against the metals including the precious metals.

But, in my view is that once the rate hikes are announced, it could signal a turnaround for gold. The World Gold Council conducted a study using simple regression analysis for the period of January 1975 to May 2013 to observe the price movements of gold under different real interest rate scenarios. The analysis shows that the average monthly return of gold since 1975 is 0.6 per cent which roughly translates into a 7.5 per cent return in annualised terms.

Also, current prices are around or below the cost of production for many mines in the world. This could prove a fundamental strength going forward.

The fall in prices could tempt central banks in countries like China, Russia, Turkey and India, who have bought decent quantities post the 2008 financial crisis, to diversify some more into gold.

Conclusion: As much as it is sounds as though it is the curtains for this asset class presently, I view this as an opportunity for long-term investment in gold.

Opportunities are always presented in adversity and the smart investors take it with open hands. That said, there is scope for further downside in the short-term and timing the market while doing bottom picking is tough.

We expect prices to bottom out in the $955-1040 zone.

In the local benchmark MCX exchange, that could roughly be in the range of 23000-24000 dependent on the Indian rupee movements. If the rupee tends to appreciate, then the lower end of the zone is likely, and if it depreciates, the higher end of the zone could be a potential bottom.

It could take more negative factors than that in play presently, to push gold below these long-term supports mentioned above.

Gnanasekar Thiagarajan is a Director at Commtrendz Research and a consultant to commodity bourses and corporations both in India and the overseas. He has more than 20 years of experience in commodity and forex trading and was formerly a forex dealer with the Bank of Nova Scotia.

**Investors are requested to consult their financial advisors before making investments based on the above recommendations.

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