Will the Rally in Gold Continue After the Union Budget 2021 Announcements?

On the onset of coronavirus pandemic, the world's top-five central banks ----the U.S. Federal Reserve (Fed), the European Central Bank (ECB), the People's Bank of China (PBoC), the Bank of Japan (BoJ), and the Bank of England (BoE)----injected around 6 trillion USD of liquidity in the global financial system.

Such unprecedented monetary and fiscal response proved negative for fiat currencies. And as a result, gold prices staged an extraordinary rally across the globe in 2020. Investors took refuge under gold considering it to be a safe haven, a store of value, a hedge (to protect their savings and investments), and an effective portfolio diversifier during the times of uncertainty.

That said, central banks bought far less gold in 2020--particularly in the second half of the year. Their annual purchases came to 272.9 tonnes, almost 60% lower than the previous years, as per the World Gold Council (WGC). Nevertheless, the central banks maintained healthy gold reserves amidst times of the pandemic and heightened global economic uncertainty being well aware of the importance of gold in the central banks' reserve management.

The investment demand for gold jumped 40% Year-on-Year (Y-o-Y) in 2020 with Gold Exchange Traded Funds (ETFs) witnessing a 120%, observes the WGC.

On home soil, the full-year demand for precious yellow metal plunged by a noticeable 35% to 446.4 tonnes in the year gone by on Y-o-Y basis-the lowest annual number reported in the last 26 years. The total investment demand for gold fell 11% to 130.4 tonnes from 145.8 a year ago, according to WGC.

However, you need to decipher these numbers correctly. India observed one of the strictest lockdowns of the world owing to which many investors held back their gold purchases in the first half of 2020. The drop in investment demand for physical gold in India doesn't indicate any ebbing of its popularity. It only highlights that a lot of investors, especially in the rural markets, still prefer physical gold (in form of bars, coins, jewellery) to deploy their savings.

In the urban regions (in bigger towns and cities), the popularity of gold ETFs (a paper form of investing in gold) is on the rise, especially among young and savvy investors (see Graph 1).

Besides, the performance of Sovereign Gold Bonds (SGBs) also made a shift in preferences amply clear with the first five tranches of SGBs in FY21 garnering Rs 8,500 crore, which is 47% of the total corpus mopped up under SGB since 2015. The AUM data for other series wasn't available at the time of publishing this article.

What to expect in 2021?

Towards the end of 2020, gold experienced some correction as the economic outlook (powered by various vaccine programmes) improved.

According to International Monetary Fund's (IMF's) latest forecast, the global economy is likely to grow at 5.5% (0.3 percentage points higher than the previous estimate) in 2021 and 4.2% in 2022. The Union Budget 2021 announcements, which address growth concerns, would prove supportive to clock higher GDP growth readings.

That said, the concerns over the virus persists and it would be premature to say that the pandemic is behind us. Thankfully India hasn't experienced a major second wave of COVID-19; but most parts of Europe and the U.S. still remain badly affected by the new mutated variant of coronavirus, which is said to be highly contagious. If India does witness a second wave, it could weigh on GDP growth regardless of the government's announcement to address growth concerns.

In the U.S., the newly elected U.S. President, Joe Biden, recently announced a massive USD 1.9 trillion coronavirus stimulus package to tackle the economic fallout of the pandemic. But note, this may not necessarily reap the required results very soon in terms of economic recovery and controlling the new cases of infection.

China has witnessed resurgence in new cases (from mid-December 2020) of coronavirus in its northern provinces of Hebei, Heilongjiang, and Jilin.

Factors that could drive the gold prices higher in the calendar year 2021 are:

• The risk of a new mutant strain of the virus derailing global economic recovery. Keep in mind that the COVID-19 vaccine has only recently received emergency approval and is yet to be medically administered on a majority of the population. Besides, taking the vaccine may not necessarily prevent the spread of infection. Plus, the efficacy of the COVID-19 vaccines on the newly mutated virus is yet to be ascertained; because when these vaccines were under trials and being developed, the new mutant-strains were not heard of that much and the necessary rigorous rounds on trials on those mutant strains (the UK variant B.1.1.7, the South Africa B.1.351, and the Brazilian variant B.1.1.28.1) hadn't been conducted.

• Muted consumption in many parts, as people are focusing on bare essentials.

• The easy monetary policy actions adopted by the central banks in developed economies

• The problem of high debt and low economic growth. Global debt may break new record high-touch US$ 277 trillion by the end of the year (representing a global debt-to-GDP ratio of 365%), according to the Institute of International Finance (IIF).

• Geopolitical equations may continue to remain tense across many parts of the world in the U.S., U.K., China, India, North Korea, South Korea, and in particular the MENA (the Middle East and North African) region. Any escalation of bi-lateral or multi-lateral issues may be a huge negative for the prospects of the global economy.

• The potential risk to the inflation trajectory (mainly on account of food).

• The soaring equity market valuations and limited upside in high-quality bonds.

On this backdrop, the spotlights would continue to be on gold, it may exhibit its sheen and may attract investors even in 2021.

If the economic growth rate and consumption improve in India and China (the two major consumers of gold), in my view, gold demand would lap up at relatively low prices. In the Union Budget 2021, Finance Minister, Ms Nirmala Sitharaman proposed to reduce the customs duty on gold to 7.5% from 12.5% making it cheaper for people to buy gold--this would push the demand for gold upwards.

Likewise, central banks would also continue to be net purchasers of gold (as they have been for last many years) in a low-interest rates scenario. However, as pointed out by the WGC, the performance of gold as an asset class may be more subdued in 2021 in comparison to what we witnessed in 2020 (and in 2019).

The role gold can play in your portfolio in 2021 and beyond...

Gold would play its role of an effective portfolio diversifier, a hedge (when other asset classes fail to generate alluring returns), a safe haven, and command a store of value.

A point to note is: unlike financial assets, gold is a real asset. This means, gold does not carry credit or counterparty risk and is usually supported by high inflation. This is why gold has demonstrated its appeal and fared well over the long-term (see Graph 2).

In my view, it makes good sense to buy gold strategically and be a smart investor. A weak dollar, low policy rates, and accommodative monetary policy stance, along with looming uncertainty would keep the spotlights on gold.

Gold will remain one of the most sought-after avenues to park hard-earned money among smart investors.

The long-term secular uptrend exhibited by gold is something that invites attention and highlights the importance of owning gold in the portfolio with a longer investment horizon.

Allocating at least 10-15% of your entire investment portfolio to gold and holding it with a long-term investment horizon will be a smart and sensible strategy. Invest in gold the smart way through gold Exchange Traded Funds (ETFs) or gold savings funds or Sovereign Gold Schemes.

Happy Investing!

Warm Regards,
Rounaq Neroy
Editor, Daily Wealth Letter

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