The Lust For Yellow Metal Is Back — And Not; And What It Means For India

The present pandemic has resulted in a coordinated policy response from leading central bankers across the world — causing interest rates to be at historic lows in several parts of the world.

We are living in a world of excess liquidity and a regime of low interest rates that are likely to continue in the foreseeable future.

The initial days of the pandemic saw an unprecedented exit of investors as they reallocated their portfolios away from equity assets and rushed towards safe investments such as government securities, the US dollar and even gold.

Investors have added gold and specifically gold-backed exchange traded-funds to their portfolio.

A total of $9.7 billion worth of such assets were added in July alone, while India saw $98 million of inflow into gold Exchange Traded Funds in July as per the World Gold Council.

Despite gold being a safe asset to hold, especially as there is uncertainty regarding future economic prospects, the demand for physical gold seems to be struggling in the world’s largest market for the metal — that is, India.

However, gold prices registered a strong rally before the reversal over the last few days.

The recent increase in government security yields and the deadlock around the US stimulus are reasons behind the correction.

Investors, in general, are not very enthusiastic over the political development with respect to the stimulus bill in the United States and this has impacted their outlook towards another safe asset, the US, which registered a 5 per cent fall in July alone, while Euro gained nearly 10 per cent.

This sparked a hypothetical discussion whether it was the end of the US dollar’s hegemony, a discussion which happens every time the dollar weakens.

Despite the sluggish economic conditions, and its spill over impact on the financial performance of companies, the yellow metal is no longer attracting investors the way it did till last month.

The reason for this could be the increase in yields, especially for the US 10 year treasury bonds which may have reignited investors sentiments towards them.

When it comes to safe assets, gold, and US 10-year bonds are typically regarded as the safest financial assets by investors, while some also hold US dollar for speculative purpose and regard it as safe, given US’ stable inflation.

An increase in the yield of a bond increases the opportunity cost of non-yielding assets such as US dollars or gold.

This is precisely why we see a sudden reversal in portfolio allocations away from bullion and towards interest bearing government securities.

However, a fresh round of stimulus and proactive action by the US Fed could further push down yield and this could coincide with heightened uncertainty regarding economic recovery combined with the political process of US Presidential elections.

These factors can further result in investors and financial market participants to rush towards the safety of the yellow metal due to heightened uncertainty.

The key issue is of investor preferences at a time of unprecedented uncertainty, which has led to a rally in global equity markets and has pushed up the price of certain commodities.

This rally is a direct consequence of liquidity easing across the globe by proactive central bankers in an attempt to absorb a part of the economic impact of the current pandemic.

However, the strong performance of certain assets even as real economic activity is far from being normal poses as a key challenge going forward.

In the event of a change in investors preferences or attitude towards these assets, we will witness a sharp correction in their prices which can have catastrophic implications for the prospects of global recovery.

This is precisely why central banks and policy makers must focus on reducing as much of uncertainty as possible going forward — especially when it pertains to the likely policy response that they are willing to and capable of should the situation worsen in the near future.

A soft landing is of essence to prevent the present economic slump to deepen across the world which will further pose as a challenge for developing economies such as India to get back to its potential rate of growth in the post Covid world.