Managing Expectations: Why Gold Should Thrive

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Recently by Frank Holmes: Gold and China: Where the Bulls and Bears Square Off

It was a challenging week for gold investors. Although the yellow metal has been on a spectacular 11-year bull run, recent strength in the economy has some thinking gold’s heyday is over.

As I often say, investing, like life, is about managing expectations – even throughout gold’s decade-long rise, price action over the short term can go both ways. It helps to look at what happens after short-term drops. For example, looking at the past decade of one-day 5 percent declines in gold, you can see that this event is pretty rare. In 2006, gold dropped more than 5 percent in a day only two times. In 2008, there were three such events. Another one occurred at the end of this February.

The 1.7 percent drop experienced over the past month shouldn’t surprise gold investors given the seasonal pattern for gold. Whereas gold rises nearly 2 percent in both January and February, over the past 11 years, it’s been a non-event for gold to correct in March.

In addition, it’s a good reminder that bullion has historically been less volatile than the stock market: the 12-month rolling volatility over the past 10 years for gold was 13 percent. For the S&P 500 Index, the 12-month rolling volatility over the same period was 19 percent.

This March, there seemed to be one main driver eight thousand miles away negatively affecting gold prices. I often say that government policy is a precursor to change, and fiscal policy strongly affected the Love Trade in India last month. To trim its current account deficit, India’s finance minister proposed doubling the customs tax on the precious metal. It was soon reported that jewelers closed shops in protest.

As a result, gold imports into the world’s largest gold market fell 55 percent.

It’s not the customs tax that has the gold shops boycotting, says UBS Investment Research firm. Jewelers’ "prime gripe is with the new 1 percent excise duty on unbranded jewelry" leading to a greater recording of gold transactions, which means more regulation and red tape. What’s so egregious to jewelers is the excise tax will be retroactive so those shop owners holding old gold stocks will have to pay duty on those as well, says UBS.

I believe this is only a temporary sell-off for India. As I often discuss in my presentations, traditional festivals and holidays drive gold demand in India because of their strong history with gold. With their love for the yellow metal, Indians hold the belief that gold "will perpetually rise," although there are certain buyers that wait for a "psychologically important $1,600 level," keeping in mind the strength of the rupee, says UBS.

While the seasonal Love Trade period for gold generally falls between August and February, an important holiday is coming up which has historically driven higher sales of gold. Akshaya Tritiya festival occurs on April 24 this year. This is an important occasion for Hindus, celebrated annually in late April or early May, depending on the Hindu calendar. Buying and wearing of gold jewelry is important on this day, as UBS says it’s one of the two "biggest gold buying events" in the Hindu calendar. The second event is Dhanteras, which occurs during the peak seasonality period for the yellow metal.

How important is this festival for the gold market? UBS analyzed the buying data from India last year when Indians celebrated Akshaya Tritiya festival on May 6. It found that "physical sales to India peaked four days beforehand." Also, "sales were consistently above average for 13 working days" before the festival because local banks and jewelers restocked their inventory.

Two factors need to change to help sales in India this year, warns UBS. The firm says the jewelers’ strike needs to end, and, according to one local who talked with UBS, it would help gold sales if the price of oil would reverse – this would "relieve some of the current account pressure and perhaps allow for more flexibility with regard to gold imports."

What won’t change over the long-term is Indians’ gold-buying behavior: Indians "have an extensive cultural tie to gold" and this "is not changing," says UBS.

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Frank Holmes is chief executive officer and chief investment officer of U.S. Global Investors Inc. The company is a registered investment adviser that manages approximately $4.8 billion in 13 no-load mutual funds and for other advisory clients. A Toronto native, he bought a controlling interest in U.S. Global Investors in 1989, after an accomplished career in Canada's capital markets. His specialized knowledge gives him expertise in resource-based industries and money management.

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