Price of gold to remain volatile this year’ Interview in Indian Express: 9th February 2009

While other commodities are slowly heading southward, gold is maintaining its upward stride. In January this year, it touched yet another high and is now trading above Rs 14,000 per 10 grams. Suneeti Ahuja spoke with Madan Sabnavis, chief economist, NCDEX, on the future course of the metal and reasons for such high volatility.

How do you explain the heightened volatility in gold?
The price of gold has been volatile for a number of reasons. The demand for physical metal has been fluctuating as it is influenced by the movement of the dollar vis-a-vis the euro. Gold is regarded as a substitute for the dollar and its price rises when the dollar weakens as money moves into the yellow metal. On the supply side, the decision taken by the European central banks to offload gold reserves has varied between induction and reduction of such supplies. Further, the volatile crude Oil market has extended its influence on the price of gold, which bears a long-term relation to the liquid.
•Is the demand pulling the prices artificial or genuine?
The demand is genuine since the dollar strength is real. The physical demand for gold grows at a normal rate or trend rate as there is a tendency for people to demand gold to a certain extent every year, where the price effect is more at the margin. However, the clinching factor here is the relationship with the dollar. The dollar has been quite whimsical last year which has led to erratic demand for the metal.

•Is it a good time to buy gold at its 14,000 rate? Or do you see correction taking place in near term?

In volatile times, one always takes a calculated risk as one does not know how the dollar will behave. Theoretically, a high current account deficit in the US would mean that the dollar will fall and gold will rise. But the actions of the Federal Reserve (Fed) as well as the impact on exchange rate changes the equilibrium constantly, in turn making the price volatile. Last year, the price rose and then suddenly fell as the dollar strengthened amidst the financial crisis. The European Commercial Bank (ECB) has also kept a watch on its interest rates to ensure that the euro does not appreciate too much lest export competitiveness is affected. So, one is not sure of the direction of the movement, let alone a correction.
•What is your outlook for the yellow metal for this year?
It would be difficult to take a directional call here as there would be variations during the year based on the Fed and ECB actions, which in turn will have a bearing on the dollar. In the long run, the dollar has to fall as long as the current account deficit is high at around 4 per cent of GDP. But, in the short run there would be corrections as the present slowdown will tend to reduce imports and push up the dollar. So actually we are taking a call on when the US economy will recover to expand the deficit, which in turn will impact the dollar. The best answer is that gold will be as volatile as last year with no specific direction being conjectured as of now.
•What do you think is better for the retail investor: buying gold ETF or physical gold?
It depends upon two factors: the need to hold on to the metal and risk propensity. In India, gold is held primarily for traditional reasons and the price is not a factor in a traditional household. Typically, we buy gold in terms of quantity during festivals or marriages and it is denoted in grams or tolas and not monetary terms. The individual investor would not really be buying and selling gold per se as it is not convenient to deal with the physical metal. This means that the investor would prefer ETF or futures. ETFs are good for those who do not have to take a personal call and can leave it to the experts to do the trading. Therefore, there will be a different set of investors in each of the two alternatives. The ETF option has, however, not really caught on.
•Do you think the current volatility will affect domestic consumption?
Not really, because the physical demand is more or less fixed and not too responsive to price changes. As far as investors are concerned, volatility should lead to higher trading interest as returns are commensurate with volatility.
What is your view on other commodities? Should retail investors take exposure to commodities?
Investing in commodities is a useful option but one needs to understand the fundamentals otherwise incorrect decisions can be made. Commodity prices are driven by fundamentals and as fundamentals change depending on production conditions, supplies tend to be variable which leads to higher volatility and hence returns. Therefore, one needs to make informed decisions and have adequate knowledge before entering this market as an investor. The market so far has taken care of the interests of hedgers to a certain extent but the retail investor is still a mile away and would have to tread carefully.