Should You Buy Gold Now?

Gold price reached its one month high this morning, supported by hopes for additional stimulus by the Federal Reserve, after last Friday’s weak employment report. The precious metal is now up about 4% year-to-date, after a weak price performance for the last four months.

According to the World Gold Council, the worldwide demand for gold was down about 5% during Q1 2012 compared with Q1 2011, mainly due to import duty in India and higher gold prices.

Demand for the yellow metal in China was up 10% as the country is now emerging as the largest consumer of gold, leaving India behind.

In India, the demand for gold fell during the quarter (jewelry demand down 19% and Investment demand down 46%)due to imposition of import duty by the government as well as increase in the price of gold (resulting from sharp decline in the currency). Gold price in India is now at its all-time high (in rupee terms).

During the first quarter, the central banks continued to add to their gold holdings, in order to diversify their reserves. Further, per data released by IMF, central banks’ gold purchases continued in April as well. Russia, Mexico, Kazakhstan, Turkey and Philippines have been the main purchasers this year.

Further, China’s import of gold from Hongkong this year is at record high levels, leading to speculation that mainland China is adding to its gold reserves.

There was an interesting article in WSJ a couple days back, which analyzed gold’s ability to act as “safe haven” using the short-term correlations with the stock market and bonds.

The article inferred that gold acts as safe haven “when it wants to be”. Like while it rose two years back over fears over Greece whereas in the last few weeks, it has moved opposite to the “safe” bonds which jumped as fears over “Grexit” intensified.

In my view, short-term correlations tend to be volatile since the investment case for gold does not rest solely on its “safe haven” status, but many investors especially in India and China invest in gold due to “store of value” status.

Earlier this year, in addition to the reduced demand from India (India and China together account for more than 40% of the global demand), strength in the US dollar also affected the gold price.

Several studies have shown that over the longer term gold has the ability to hedge against inflation as also remain uncorrelated with the stock market returns.

So, there is a strong possibility that the ounce of physical gold that you buy now (or buy shares in gold ETFs like ( GLD - ETF report ) or ( IAU - ETF report ) will preserve its purchasing power in the long-run, whereas other safe assets like bonds will decline in value in real terms.

Gold has been rising now for the last 11 years in a row and some analysts say that it may now be heading for its 12^th year of annual gains. And, there are others who think that the gold’s 11 year bull-run may be over now.

What doyou think?