She diligently pays her taxes on time, has no unaccounted money and the only property she owns is a 2-BHK flat bought with a loan. Yet, Abhilasha Kumar was in knots last week following rumours that the government may place a limit on the gold held by an individual. “I have been investing in gold for years. How can they suddenly stop me from doing so?” says the Gurgaon-based consultant in a large MNC. Abhilasha is not alone. Though the Finance Ministry has clarified that no limits have been placed on gold ownership, a lot of people expect a crackdown on unaccounted wealth stored in the form of gold. Almost 63% of the respondents to an online survey expect limits on how much gold an individual can own. “This is the next logical step in the war against unaccounted wealth,” says a Delhi-based chartered accountant.

Indeed, the yellow metal is a convenient way to store black money. It is easier to hide and more liquid than real estate. Immediately after the demonitisation was announced on 8 November, there was a mad rush to buy jewellery. Gold prices surged from Rs 31,000 to Rs 50,000 per 10 gms for those buying with Rs 500 and Rs 1,000 notes. Even weeks after the ban, private deals were being struck to convert the banned notes into gold and silver. Media reports say there was a sudden surge in gold imports in November. Almost 100 tonnes of gold was imported after the demonitisation announcement. This is 20% of what is normally imported in a whole year.

MOST PEOPLE FEAR GOVERNMENT MAY PUT LIMITS ON OWNING GOLD

The online survey was conducted from 30 Nov to 1 Dec 2016. It got 556 respondents. Figures denote % of respondents.

HOW MUCH GOLD DO YOU OWN?

42% of those with over 500 gm want to buy more.

A significant number of people hold more than 500 gms of gold.

IN WHAT FORM DO YOU OWN GOLD?

Jewellery (inherited) 67.90%

Jewellery (self bought) 67.20%

Gold coins and bars 29.20%

Gold ETFs and funds 9.20%

Sovereign gold bonds 5.50%

Gold price on decline

The rumours about limits on ownership and scrutiny by tax authorities come at a time when gold is already facing the headwinds of macro-economic factors and global developments. Gold lovers were dreaming of a big rally in the yellow metal after Donald Trump was elected US President. However, after an initial spurt, global gold prices crashed and are now almost 10% below the pre-election level (see graphic). The same story played out in India. Gold demand surged after demonetisation, but has now slumped. Jewellery shops are almost deserted even though this is the start of the busy wedding season. What should investors in gold do now? Will prices go down further? Gold prices are affected by several factors so let us analyse one at time.

DOMESTIC GOLD PRICE MAY DECLINE…

Demonetisation and fears of curbs have dampened gold demand and prices.

Compiled by ETIG Database

Rise in the US dollar is keeping the domestic gold price from falling too much.

…BUT NOT AS MUCH AS GLOBAL PRICE

Donald Trump’s sober speeches have turned the tide and caused gold to slide.

After hitting a high in 2011, international price of gold has been on a downtrend. They got a boost due to the uncertainty about the US presidential election (especially the fear that Trump will win). However, after he was elected, Trump turned sober in his views and gold prices resumed their downtrend. “It is not correct to assume that whatever Trump said during electioneering will be implemented now. The new president will be surrounded by not just his own advisers, but all advisers (government employees who were in the system for decades),” says Rory Tapner, Chairman, Sanctum Wealth Management.

The uncertainty has not gone away forever, though. Trump may not implement all his election promises, but he may implement some of them. Since the economic policies of the new US government are expected to be radically different, there will be some uncertainty in coming months. “Gold usually does better in uncertain times. Confusion about the possible economic policies of the new president is likely to be good for gold,” says Jodie Gunzberg, Global Head of Commodities and Real Assets, S&P Dow Jones Indices.

WILL YOU BUY GOLD IN THE COMING MONTHS?

Figures are % of respondents. In following graphics, figures will not add up to 100 because of multiple responses.

IF YES, WHY?

Personal use is still the most important reason for buying gold.

IF NO, WHY?

Most people expect better returns from other avenues.

GOLD DEMAND HAS DIPPED IN INDIA

Though consumption is up, investment demand has come down drastically.

Source: World Gold Council; 2016 value only for the first 9 months.

If conditions remain like this, gold demand for 2016 will be the lowest in the last 10 years.

Strengthening dollar

Since international gold is traded in US dollars, the greenback’s continued strengthening will have a direct impact on gold prices. The Dollar Index has already breached a 14-year high level. The Dollar Index is calculated based on its movements against a basket of currencies from the main trade partners of the US. Experts believe the Dollar Index could flare up further in the coming months. “The Dollar Index has already crossed a major resistance (double top of 100.5) and it is possible that it may move up to 106 soon and 1,012 later,” says Ravindra Rao, Head of Research, Anand Rathi Commodities.

However, experts are hopeful that this trend won’t last long. “The dollar is already at a high level and also well above its longterm average. So the chance of its falling is probably more than the chance of it rising,” says Gunzberg. “The continued strengthening of dollar will make Trump’s domestic manufacturing and export-oriented agenda more difficult to implement,” says Tapner.

US Fed actions

Historically, gold prices have remained subdued whenever the US Federal Reserve has been on a rate hike spree. Gold prices fell in 2015 because the Fed was expected to aggressively hike interest rates. However, the rate hikes have not yet happened, which led to some recovery in gold prices. The Fed is scheduled to meet on 13-14 December and most experts agree that a 25 bps hike in December is already priced in. “Gold will remain weak if US Fed increases rates. If that doesn’t happen (which is a remote possibility), gold price will rally,” says C.P. Krishnan, Whole Time Director, Geofin Comtrade.

In addition to the possible rate hike, the market is also awaiting the guidance from the Fed on future rate hikes. “Janet Yellen, chairperson of US Fed, is expected to give some hint about the number of hikes expected in 2017. Gold prices will fall if it is aggressive (more than two hikes in 2017), else it may remain subdued,” says Kishore Narne, Associate Director, Motilal Oswal Commodities Broker.

DOLLAR INDEX ROSE 25% IN TWO YEARS

But some experts say this trend won’t last long and the index will recede.

Source: Bloomberg

Dollar may continue to be stronger in coming months.

GLOBAL GOLD DEMAND IS SLOWING

Around 70 tonnes have moved out in the past 20 days.

Investment demand is moving out of gold due to dollar strengthening.

Gold demand

Gold demand has also slipped in recent years. Gold demand can be split broadly into two: investment demand and consumption demand. With the tide turning, investors have also started deserting gold now. As visible from the SPDR Gold Shares Holding Chart, around 70 tonnes have already moved out in the past 20 days. This trend may persist for coming months if the dollar strengthening continues.

More worrying factor for gold is the fall in consumption demand from key nations like India and China. “China and India are the biggest consumers. So the gold demand coming down there will affect the international gold price also,” says Krishnan. Domestic demand has fallen from a peak of 1,002 tonnes in 2010 to 858 tonnes in 2015. In the first nine months of this year ( Jan-Sep), domestic demand came down to 441 tonnes, down by 29% compared to 621 tonnes during same period of last year.

A series of measures taken by the Indian government to reduce physical gold consumption has also started yielding results. For example, the government has been able to wean away a major part of investment demand from gold bars and coins to Sovereign Gold Bond Scheme. However, the Gold Monetisation Scheme, which was aimed at bringing in the existing gold hoard to the market, has not been that popular (see box). A hike in import duty, which is now at 10%, is another attempt to reduce domestic gold demand.

Demonetisation impact

Gold demand is maximum during the fourth quarter (Oct-Dec) because of Diwali and the marriage season. Though there was some pick up in the last quarter of 2016, most of the demand vanished after demonetisation.

IMPORT DUTY HELPS GOLD

The 10% duty on imports buoys the domestic price of gold.

Compiled by ETIG Database

Since the government’s focus is to rein in gold demand, the import duty may not be cut.

“Local gold demand has come down drastically after demonetisation. People are using the available cash for other purposes,” says Krishnan. “There is almost a standstill in the market and gold sales from wholesalers to retail jewellers have come down by around 90%. The situation is expected to remain like this till 31 December,” says Hasmukh Bafna, President, Gold Chains & Jewellery Wholesalers Welfare Association.

Despite the glum tidings for the gold trade, the World Gold Council is putting up a brave face about the Indian demand in the fourth quarter. “Diwali was already over before demonetisation. Though some pockets like casual purchases (non wedding purchase) may get affected, people are still buying jewellery for marriages. Since most jewellers have long-term relationship with their customers, these transactions are happening through cheques or cards. So we are not revising the forecast for the year,” says Somasundaram P.R., Managing Director-India, World Gold Council.

Outlook for gold

What will happen if the price of gold falls in the international market? “We are generally bearish on gold for the next three months,” says Krishnan. Others agree that gold is headed for lower levels. “International gold prices may come down to around $1,100 by the first quarter of 2017,” says Rao.

But the decline in the global gold price may not be mirrored in India. “Domestic gold prices are expected to remain range bound with a weaker bias in the next quarter,” says Narne. This is because the dollar is strengthening against the Indian rupee. This depreciation in rupee will act as a cushion and prevent the domestic price of gold from falling too much. Also, the depreciation of the rupee may not be as pronounced as the decline in other currencies. “FCNR redemption is already over. Current account situation usually improve during January-March quarter also, so the rupee weakness will not be as much as the currencies from other emerging markets,” says Upasna Bhardwaj, Senior Economist, Kotak Mahindra Bank.

Rising yields are a worry

However, the sudden spurt in government bond prices (or fall in yield) due to increased liquidity from demonetisation may be a factor to watch out for. This sharp fall in the yield is happening at a time when the bond yields are going up in other markets. For example, the 10-year bond yield in the US has risen by 47 bps in the past one month, while it came down by 57 bps in India. The difference between the US and Indian yield has gone below 4%, the normal forward premium for a year (see chart). “Narrowing interest rate differential is a worry and this may cause FII outflows from debt and that could be another source for further weakness in rupee,” says Bhardwaj.

High import duty on gold, placed at 10% now, is another factor to be considered. Any reduction in the import duty can bring the domestic gold prices down by that extent. However, the government’s focus now is to bring down domestic consumption, so no one is expecting an immediate cut in the import duty. “The import duty will come down only if this high import duty results in large-scale smuggling. Since there is no proof that this is happening, the government may not cut import duty soon,” says Jayant Manglik, President, Religare Securities.

What should investors do

Though most experts are bearish in the short-term, it still makes sense to have a part of your total portfolio in gold. But financial planners say this should not be more than 5-10% of your total investment portfolio. “Gold is no more a safe haven, so limit the exposure to 5% of your portfolio,” says Gurgaon-based financial planner Taresh Bhatia. The rupee is expected to continue weakening against the dollar, which could benefit gold. “Our foreign exchange reserves are increasing along with a weakening rupee. That means the RBI and the entire economic system prefers a weak rupee. This trend is expected to continue in the coming years as well,” says Manglik. This weakening gold has protected Indian gold investors in the past also. “Historically, Indian gold investors have never lost money in any five-year holding period, mostly because of this rupee depreciation,” he points out.

Also, the uncertainty in the global economy is not yet over. Though one major event (the US election) is out of the way, several such events are expected in the coming months. “It is always better to have some small allocation (say 10-15% of the portfolio) to gold because global uncertainty will always be there. Once the Italian referendum is over, some other event will come,” says Rao.