What drives gold’s performance in the short term and how does it benefit you?

Gold as an Investment 30 Oct 2020

Investing in gold to achieve long-term financial goals is a common practice among avid investors across the world. Gold is proven to yield high returns in the long run, often outperforming other equity-linked assets. The upswing in gold prices during the current global economic slowdown has also got a lot of people thinking short-term as they sell gold to meet their immediate financial needs.

If you are closely tracking gold’s performance to decide on your investments, understanding the factors that drive gold prices would help you anticipate the performance of gold and make the most out of your investments.

Factors that affect gold prices and investor returns in the short term

  1. Geopolitical tensions:Such events undermine investor confidence; for instance, the recent US-China tensions played a key role in driving investors to buy gold, even as the coronavirus crisis raged on.
  2. Economic growth:When incomes increase, there is usually an uptick in the demand for gold for jewellery, long-term savings, and technology. In fact, in India, gold demand rises by 1% every time the national per capita income level rises by 1%.

  3. Uncertainty and risk: Since gold is regarded as a safe-haven asset, it is a preferred option during market downturns. Market risk is subject to changes in relative flow of bonds and equities, assets held in reserve by central banks (In India, the Reserve Bank of India), international crude oil prices, inflation, inflation rate, and expected fluctuations in the value of gold.
  4. Monetary policy changes: An increase in interest rates on government securities like sovereign bonds also affects investors' appetite for gold. Of the two, they tend to prefer whichever asset provides a higher potential for returns, after factoring in the effects of inflation. In times of economic crisis, gold is the safest option by far.
  5. Opportunity cost: How investors perceive competing assets also affects the demand for gold, which includes bonds, currencies, and the stock market. For this purpose, 10-year bond pricing benchmark rates and equity performance in both developed and emerging market indices like S&P 500 and the Bombay Stock Exchange respectively are compared. To know more, read how gold compares to other asset classes.
  6. Interest rates: When interest rates are low, investors prefer to exit other investments and park their funds in gold. However, gold always tends to perform positively in the long run, which makes a case for staying invested. To know more, read How has gold performed in the last 10 years?.
  7. Momentum:The inflow and outflow of investment (equity and bond) into the economy and stock valuations can also affect investment attitudes towards gold. Returns from gold investments, COMEX futures positioning, and ETF flows are variables that primarily determine whether gold's performance will intensify or diminish.

Related:How is gold price determined?

Investing in gold for the short term

A short-term investment is relative to your own investment goals and risk tolerance. However, as a rule of the thumb, any investment made for two months or less can be considered short-term. These transactions are called contracts or trades where you can benefit from short-term price movements.

Derivatives, Futures, and Exchange Traded Funds (ETFs) are some popular avenues for short-term investment in gold. Normally, it is only experienced investors who can yield high returns from such investment avenues since they are able to predict market behaviour and invest accordingly.

Investing in a staggered fashion can provide better returns than doing so intermittently, especially if you are a novice investor.

How does it help?

Since July 2019, mutual funds investing in gold have provided investors returns of 43.16%, outperforming all other alternatives. Gold ETFs come with no entry or exit charges, which make them attractive avenues for small investors. Moreover, gold provides healthy liquidity, and this can be a boon during a crisis that leads to widespread layoffs and salary cuts. One reason for the liquidity of gold is that average trading volumes for gold exceed that of any other commodity.

Since gold performance closely follows inflation levels, it help’s you diversify your portfolio and safeguard your investments against market downturns. However, when choosing the right form of gold to invest in, as with all investment decisions, your own financial goals and risk-bearing potential should take priority over the desire to time the market for speculative gains.

Related:The role that gold can play in your portfolio (for retail investors)

Who is it for?

You, as an investor, might have the intent to stay invested over the long term. Gold prices typically average out over a period of 7-10 years and give higher returns as compared to other commodities. On the other hand, if you have diversified your gold investments in a mix of equities (mutual funds), stocks, and bonds (government guaranteed), you are likely to see better returns on investment. This is because gold prices are influenced by multiple short-term factors that cannot always be predicted.

Early optimism that the economy would recover faster than expected is balanced out by reports that economic growth may continue to slow down as the world continues to grapple with the COVID-19 pandemic. As an investor, the decision you must make is – in what way can the gold you hold bring you the most relief in the short term, and the most gain in the long term? If you are facing financial difficulties, you may want to sell your gold or take a gold loan, and stabilise your finances. But if you can resist liquidating your gold investments, you can benefit from the long-term gains of staying invested in gold, despite market ups and downs.

If you are looking for more guidance on this subject, here is Economist Vivek Kaul on why gold makes sense as an investment today.