Gold - Sudden Love Lost, Does it Hurts?

Why had Gold risen so far and why such a sudden lost of love with yellow metal?

Since 1999, gold has appreciated 6x. Just before 1999, Asian tiger economies went bust and 1999 onwards we saw infamous Dotcom bust and 2008 financial crisis all of which led to inflation that led to major currencies losing its value as Central banks kept printing Dollars and Euros. Gold has inverse correlation with US$ or direct correlation with supply of money i.e. printing of currency that causes monetary debasement.

Gold pays no interest but bonds do hence rising bond yields will make Gold unattractive. Hence Gold has inverse correlation with bond yields and hence interest rates.

Gold is a bet against inflation since appreciation in Gold beats lowering interest regimen on fixed income instruments such as fixed deposits. Over last 6 months commodity prices including those for metals, energy as well as agricultural commodities have come down by 20%-30% globally due to either better supply, improved supply chains or lowering demand thus reducing inflation (except in India L). Since inflation fears started waning away, investors shifted their portfolio from yellow metal. [It’s a pity that during same time India is still facing strong headwinds due to high inflation. WPI has never come below 6 over last couple of years and CPI led by food inflation has broken the backbone of middle class.]

Usually, Gold should have moved up considerably on news such as Japanese Government huge financial stimulus and instability in Europe induced by Cyprus but Gold prices hardly moved. I believe that’s because above mentioned indicators were playing contrary. Hence final blows came when Cyprus said that it will sell Gold reserves to meet shortfall. 

India with 190 billion of CAD (current account deficit) should be happy with lowering gold prices as it will reduce the import bill which along with stabilization in crude oil will reduce burden on burgeoning CAD which in turn reduces pressure on currency devaluation and recent credit rating concern. However, over last week Indian household’s investments in gold depreciated by more than 20% but since we don’t invest in gold for short term hence this should not be a concern.

Going by majority of economist’s view, Gold prices shall remain subdued for majority of 2013 and shall go back again next year. In my view, we should keep a close watch and should start investing incrementally from June onwards distributing investment over next 12 months. After all we Indians will have to part with Gold during our kid’s marriage which is still few decades away (for me :) ) and currencies will always depreciate with growing demand for food and fuel hence as far as gold can beat inflation we should be good.

Happy investing!

Update
Few weeks have gone by since I originally published above post on 20 April 2013 and today is 17 May 2013.

Markets have aligned with my predictions:

This is longest losing streak for Gold since 2009
Gold investments have almost halved in first quarter
Gold per ounce is trading at 1374.99 (Spot)
Gold ETF investment has shifted to Equities (in US market)
Inspite of Akshaya Trithya and Strike by Jewellers in Mumbai, Gold prices in retail market have gone down
Why? US economic numbers are strong indicating they won't go for another quantitative easing which means lesser dollar will be printed which in turn strengthens the currency and reduces inflation risk. Remember Gold is strongest hedge against inflation if equities are not up, by reverse logic Gold had to come down.

Don't forget to accumulate Gold from here...remember we have to marry of our kids.

FOREIGN CURRENCY RISKS FOR CORPORATES

Firms generate capital either by issuing equity or by borrowing debt and then they invest the capital to gain ROI. In current economic environment, even if a company is not exposed to foreign currency directly still it may have risks associated with foreign currency.

Various currency risks to a corporate can be broadly categorized as
1. Transaction Risk - Impacts cash flows

This risk arises whenever payable or receivable is in foreign
currency. So risk will arise if company sells on credit or pays with
delay, normally credit period is upto 90 to 180 days. Movement in
exchange risk may result in exchange risk loss or gain for the
company unless the risk is hedged, which comes at its own cost.

2. Translation - No impact on cash flows

This is less obvious as it has indirect impact on the company's
balance sheet and market rating. If company has exposure in foreign
currency by way of receviables, payables, investments or otherwise
then it has to first translate that exposure in domestic currency
before consolidating it in domestic balance sheet. Same amount of
receivables say USD 1000 in year 1 will be transalated to INR 50,000
(@50) and in year 2 it could be INR 45,000 (@45). In this case Asset
reduced by INR 5000 or by 10% YoY due to translation (assuming other
remain constant). Similarly it can also impact Debt to Equity ratio
(A = D+E), which will increase the borrowing costs for the corporate.

3. Economic Risk - Impacts unkown cash flows

Consider company X in country A and company Y in country B. Now
depending on econominc developments in two countries, their exchange
rate compared to another country say C where Customer is located can
change favorable for company X and other way for company Y which
will make X's products competitive and will negatively impact
company Y's sales forecast from the region. This is what US - China
tiff is all about. China's has artifically pegged its exchage rate
to low levels so that its products remain competitive worldwide.
Though artificially depreciating the currency has its own impact on
an economy but that is a different discussion altogether.