Why gold prices tanking to 2-yr low is good for equities, bonds

The sharp drop in gold prices in US dollar (USD) as well as Indian rupee (INR) terms is highly positive for asset classes of equity and bonds. The INR too will see strength as gold prices fall further. The primary reason for gold losing its lustre is that it has lost its value as a hedge against currency instability. Falling gold prices suggest that risk is coming back into the market.

Gold prices have fallen 20 percent from highs in USD terms since it touched peaks of USD 1900/oz in September 2011. Gold prices in INR have come off by 17% from calendar year 2012 highs to current levels of Rs 27,000 per 10 grams. Gold price fall is worrying for many, as the prices had doubled over the last five years on the back of worries of inflation and currency instability. The rise in gold prices drew in more and more investors with Gold ETFs (Exchange Traded Funds) launched in India seeing assets cross Rs 10,000 crore from an almost negligible base.

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Gold caught the fancy of investors as the Eurozone sovereign debt crisis prompted doomsayers to talk about the collapse of the Euro. Investors and speculators bailed out of the euro and got into assets like gold and US treasuries that saw prices touch record highs. In India the rupee tanked by over 25% against the dollar and inflation ruled at over 9% levels leading to a rush for gold, both physical and electronic.

[caption id=“attachment_699696” align=“alignleft” width=“380”] Gold caught the fancy of investors as the Eurozone sovereign debt crisis prompted doomsayers to talk about the collapse of the Euro.[/caption]

Gold was seen as the salvation for excesses of governments, central banks, individuals and corporates with governments, individuals and corporates spending borrowed money while central banks printed money to bring about stability in markets.

The reason for holding gold as a risk hedge is no longer apparent. Central bank efforts have helped calm down currency markets and doomsayers are now pushing their target for a world collapse by another ten years (take it as a tongue in cheek remark!). Global commodity prices are down 16% over the last couple of years as reflected by the fall in the Reuters CRB Commodity index that tracks a basket of 19 commodities. Falling commodity prices have led to inflation worries coming off.

India’s benchmark inflation index the WPI (Wholesale Price Index) printed at forty month lows of 5.96% for March 2013. India’s inflation rate has come off from over 10% levels seen in June 2010 to levels of 5.96% as of March 2013. Economic growth has fallen from 8.4% levels to 5% levels over the last two years leading to inflation coming off.

Gold prices falling are an indication of stability in currency markets and inflation expectations. The fact that risk aversion is going out of the market is highly positive for equities. Equity markets in the US, Europe and Japan have rallied by 30% to 50% from the time gold prices peaked out in 2011. Investors are placing their bets on equities globally on expectations of economies recovering on the back of central banks flooding the system with cheap money.

The Sensex and Nifty have underperformed global equities by a wide margin with just 8% gains since 2011. The fact that risk appetite is back globally will sink into Indian markets at some point of time or the other. Indian government bonds have seen yields come off by 80bps over the last one year on the back of falling inflation expectations. Bonds should see further downtrend in yields on expectations of rate cuts by the RBI in its annual policy setting on 3rd May 2013.

The rupee isyet to reflect the gold price fall and is still down 20% against the USD over the last one and half years. INR has been hit by high CAD (Current Account Deficit) that touched record highs of 6.7% in the third quarter of fiscal 2012-13. The rupee is likely to trend higher as markets factor in lower CAD as gold imports (seen as one of the factors for a rising CAD) fall and risk aversion trades taper off globally.