Yellow Metal Turns Pale

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Gold prices had been rising on the expectation that the US Federal Reserve will print more money (and thus devalue the dollar)

Most financial advisors don’t encourage investment in gold, but it continues to be a very popular asset class. It is seen by its advocates as a robust hedge against inflation, and because it is traded mostly in dollars, as protection from fluctuations in international currency rates.

However, lately the precious metal has been losing vis-a-vis a strengthened dollar. From its peak of $1900/troy ounce (33.1 gram) in September 2011, it is now down about 20 per cent. The recent fall has left investors confused because gold is said to gain in times of crisis. Why, then, is gold moving in tandem with the equity markets at a time when the Eurozone crisis also seems to be intensifying?

“Gold does take a beating when a major crisis unfolds,” says Chirag Mehta, fund manager with Quantum Asset Management Company. “As the liquidity crunch [post the Lehman collapse] had forced people to sell everything, a probable Greek exit from EU’s monetary union has weakened investor sentiment not only for gold but for all commodities,” he says.

According to Mehta, the dollar’s newfound strength rests not so much on its own merit as on the weakening of other currencies, and he predicts that the yellow metal will rise again as it did after the Lehman collapse.

Gold prices had been rising on the expectation that the US Federal Reserve will print more money (and thereby devalue the dollar). But the Fed hasn’t obliged (so far), which has deepened the risk aversion triggered by the Eurozone crisis and dampened the speculative fervour that has kept gold prices up since 2009.

India plays a crucial role in the global gold market. And yet the country is not taking advantage of the slump in international gold prices. Even the high domestic inflation has not been able to spur demand. Mehta attributes this seemingly aberrant behaviour to the depreciation of the rupee, which, he reasons, is keeping gold prices high and demand low in the domestic market. India’s gold consumption was down 29 per cent in the March quarter of 2012, over the corresponding period last year. It’s hard to forecast when gold will be back in favour with investors. But Mehta predicts that a “massive pile-up of sovereign debt across the developed world, coupled with slower economic growth” will pressure central banks to devalue their currencies, a factor that will work in favour of gold.