This article is provided by the Fund Managers of Reliance Mutual Fund before the launch of their Reliance Gold Exchange Traded Fund – An open Ended ETF. It gives you a total idea on how the Gold Market is and how it works and what the advantages to invest in it.

Q. How do you see Gold prices panning out in near future?

Gold Bars Market Outlook

• Gloomy US dollar outlook – Gold is traded in US dollar term but major consumption of gold is outside US. Hence weakening US dollars makes gold cheaper for Non- US investors and thereby increases demand for gold.
• Higher inflation expectation – Regulators have pumped in huge amount of liquidity to avert recessions. During the political meeting held in London recently it was restated that G-20 countries intend to maintain loose money policies unit economies recover clearly. The rising inflation expectation benefits gold as gold is seen as a good hedge against inflation.
• Increase in investment demand – Gold has limited stastistical correlation with any of the assets classes as factors driving gold prices are different from factors driving other markets. Hence gold acts as an excellent portfolio diversifier.The average share of gold in global portfolios is quite low and given the present fundamental setup it is undoubtedly going to go up, leading to higher gold demand. Again gold prices have exhibited astonishing performance during recent financial turmoil and that has managed to attract lot of investor’s attention. Such investors are investing in gold by way of exchange traded products and physical gold bars and coins.
• Central banks buying activity – We have seen Central banks diversifying away from US dollar and increasing its share of gold reserves to safeguard against depreciating dollar. China has announced that it has increase its gold reserves by around 75 per cent, since 2003 and now holds around 1054 tones of gold reserves but gold reserves still account for less than 2 percent of its overall reserves. China is expected to continue increasing its reserves and similar action is expected from other countries with high forex reserves and that will result in higher gold prices. The longer term outlook for gold prices seems extremely positive because of the above mentioned reasons.

Q. The Chinese government has started accumulating Gold on a large scale and has also been encouraging its people to do so which seems to be a move of the government to strengthen its currency in the international market vis-à-vis dollar. How will all this impact gold prices?
Though Chinese government has started accumulating gold they hold less than 2% of its total foreign reserves in Gold. Many experts believe they should hold somewhere between 5% to 10% of its reserve in gold. If they intend to increase gold reserves to such levels then they can eat away few years of mine supply and that should be extremely bullish for gold prices. It is widely believed that dollar is likely to depreciate in coming years and if US dollar depreciates as predicated it will deplete countries Forex reserves. Ideally central banks should diversify and increase its holding in other strong currencies. But in absence of any strong alternative currency, gold benefits the most as it acts as a good alternative to currencies. Hence if Chinese government is accumulating gold and encouraging its people to do the same., such pragmatic notion will increase gold demand and benefit gold prices.

Q. Despite the general prevalent belief that mining stocks run ahead of gold prices why has Reliance come up with Gold ETF instead of gold fund which invest in global mining stocks?
Major differences between gold mining stocks and physical gold /gold ETFs are.

• Gold mining stocks move along with equity markets and are adversely impacted by financial crises and other factors affecting equity markets. However fundamentals affecting gold prices are totally different from the factors affecting other financial markets. Hence gold tends to act as an excellent portfolio diversifier but gold mining stock may not.
• Gold mining companies can be negatively impacted by environmental issues, labor related issues, political issues in mining countries and issues relating to mining licenses. However any such issues with mining
  companies are likely to be benefit gold prices as that would deter gold supply.
• Expense ratio: ETFs have lower expense ratio compared to other gold schemes.
• Investing in Gold ETFs reduces company specific risk. Management can greatly influence the gold mining company outlook. Again many companies need to hedge their sales to avail finance and hence will not
  get the full benefit of higher gold prices.
• Generally the volatility is higher among prices of gold mining shares then on gold prices. And hence its skews the risk adjusted returns in favor of physical gold.

Because of the above mentioned reason it makes more sense for investors to invest in gold ETFs than in gold mining companies and hence Reliance Mutual Fund has come up with Gold ETF instead of gold fund.

Gold Investment Mutual Funds

Q. Apart from US dollar and demand – supply scenario, which other factors according to you could possibly have a significant influence on the gold prices?
As discussed above the higher inflation expectation, increase in investment demand and central banks activity are likely to influence gold prices.

Q. India is the largest gold consumer. Indian consumer being price sensitive how do you expect the Indian customer to behave in relation to the rise in gold prices in terms of further buying or selling off of gold?
India is the largest gold consumer since ages. Indian consumers are very pries sensitive. However a paradigm shift is required in weighing the fundamentals that drive gold prices. Till recently, Jewellery demand use to be main determinant of gold prices. However, despite weak jewellery demand over the last few quarters, gold prices have performed well on the back of strong investment demand. Again lot of jewellery demand remains uncatered as buyers were expecting a major prices correction, which never actually materialized. Such uncatered jewellery demand should cap the downside for gold prices and investment demand is expected to be main factor influencing gold prices at higher levels.

Q. What is your view on Gold as an important asset class vis-à-vis equity? What sort of asset allocation would you recommend between equity and Gold?
Gold should be looked upon as a portfolio diversifier as gold does not have statically significant correlation with any other assets class. Factors affecting gold prices are different from factors affecting other asset classes. Hence including gold in one’s portfolio should stabilize portfolio returns and give better risk adjusted returns. Ideally a portfolio should have 5 to 10 % of its investment in gold. To sum it up, we are convinced that over a period of time Gold Etfs will become more popular with the Indian investors as an asset class and not merely as a portfolio diversifier.

The views expressed herein are the personal views of the Fund Manager. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve
as a professional guide for the readers.