Buying gold on Akshaya Tritiya: Follow tradition and not Trump

Akshaya Tritiya, which falls on the coming Friday, is considered an auspicious day to buy the precious metal and this year we might witness a spurt in gold demand. The waning effect of demonetisation coupled with the recent strength of the rupee has made the asset class look attractive. But before taking the decision, it is worth considering the factors that might impact gold prices in the future as a large part of this incremental purchase is likely to be from the perspective of investment rather than consumption.

The return on gold investment for Indians would be a function of two broad factors – the movement of gold prices in the international market and the behaviour of Indian currency vis-a-vis the US Dollar.

How did gold fare in 2016?

After the stellar run in the first half of 2016, gold failed to hold on to the gains in the second half and ended the year with a point to point gains of 8 percent in prices. Volume growth was even more tepid, growing at 2 percent.

If we look at the demand drivers, jewellery demand from the two largest consumers namely China and India was negative and there was a significant decline in demand from the Central Banks as well.

Total consumer demand in India was down 22 percent, the lowest in almost a decade. Higher prices during the first half and the demonetisation shock in the second half deterred Indian jewellery buyers despite steep local discounts for most part of the year. Adding to that, introduction of a 1 percent excise duty and the requirement to quote PAN number on purchases above Rs.2 lakhs impacted jewellery purchases in official market.

Traditionally in India gold buying through cash is in excess of 80 percent and electronic payments account for a small proportion in gold purchases. The government has imposed a limit of Rs. 3 lakh on all cash transactions. The impact of the same on future gold demand remains to be seen.

The fall in jewellery and Central bank's demand was partially countered by investment demand.  In 2017, the key to watch out would be the behaviour of the smart investors and the data points they would monitor to put their incremental investment in gold.

Traditional economic theory suggests that inflation and uncertainly are the two best friends of gold. Hence, it is worth analysing 2017 from this perspective.

Global inflationary pressure: From an investment perspective, a big factor to watch this year will be the imminent rise in inflation. According to the latest projections by the World Bank, world economic growth is projected to pick up to 2.7 percent in 2017 from a sluggish rate of 2.3 percent last year. Higher growth and firmer commodity prices on account of higher spending by large economies like US points to inflationary pressure which is positive for gold.

Geopolitical backdrop: The geopolitical backdrop is no less uncertain than last year with protectionist voices from Europe to Americas raising their pitch. The war on terrorism continues providing a perfect setting to seek protection in safe haven investment of gold.

Another big driver for the gold rally in the past had been the support of global liquidity, thanks to the ultra-loose monetary policy in most parts of the developed world. However, central banks seem to have nearly reached a dead end in terms of their ability to ease further from here. This on the margin could result in waning support for gold.

Finally, what could throw spanner in the works for gold is the behaviour of the US Dollar. In the medium term, gold price and the Dollar Index generally trend in opposite directions. The reason is that in one respect gold is just another currency. As a result, when the dollar weakens on the foreign exchange market over an extended period then the USD gold price will generally rise during the same period and vice versa.

What happens to USD in the remaining eight months of 2017 is contingent on the actions of Trump. The strength of the US dollar after his victory was on the back of his promises to lower taxes and increase spending. Technically, higher spending might ignite inflation, which is negative for the dollar. But if the higher debt is financed by borrowing it would exert an upward pressure on interest rates and would be positive for the dollar.

In all likelihood, gold prices that recovered from the lows of USD 1,131 per ounce at the beginning of the year to the current level of USD 1,270 per ounce has a modest upside of 5 to 6 percent.