Tumbling Gold and the EUR/USD conundrum

The fall Gold has taken from its recent high of about $1248 to a current level of $1170 is baffling. That is not to say that it hadn't taken a real run-up over the previous few weeks. The point is that while equity markets continue to head south and US Treasury and Bund yields continue to get compressed, Gold, which should be the ultimate inflation/currency hedge is also taking the fall. Over the week ended 14th May 2010, I had expected one of two things to happen. One, Gold continues to head higher/stays stable at 1230-1250 levels while equity markets rise on low volumes. Such a scenario would have been a good time to sell into the rising equity market as Gold as a sentiment barometer still reflected serious risk-aversion. The other scenario would be a rising equity market with falling Gold. That would probably be a sign of recovery, or at least an improvement in sentiment and so the equity rally could be sustainable. Nothing, however, had prepared me for a falling equity market with a simultaneously falling Gold price.

From the Indian perspective, however, things make more sense as the recent Gold fall in USD terms has hardly translated into a fall in INR terms, while the benchmark stock market indices continue to fall. The principal reason is of course the departure of FII money from the equity market, which pushed the USD higher against the INR.

My own view is that this flight of capital into "safer" US Treasuries is the expected short-term behaviour. However, once things settle down into the "new normal", whatever that may be, we should see a significant return of overseas interest in the Indian (and other Emerging) Markets. Unless we hit another wave of "irrational exuberance", I'd expect capital to flow to countries with more transparent administrations, stronger enforcement of property rights and more predictable regulatory environments*.

The EUR/USD pair has also shown puzzling behaviour overnight with the EUR rising back from a low of below 1.22 back to 1.26 overnight. One explanation is the given the major Swiss National Bank intervention for defending the Swiss Franc, the ECB might do the same for the Euro. The shorts probably covered their positions and took their profits home. A fresh wave of panic might push it down again soon enough, though. The other important point is that we tend to forget that this is a currency "pair". Two months ago, EUR/USD was a proxy for the USD against "a foreign currency". Over the last two months, that changed into a proxy from the Euro against the world. However, given that things don't look good either for the Eurozone or for the US, the pair is now looking like a see-saw trying to figure out which one goes down first, and harder. We should be finding out soon enough.

* The recent recommendation by the TRAI for linking the 2G spectrum fees to the bids received for the 3G spectrum are just one example of the regulatory unpredictability in India. Particularly for industries with hugh capital requirements like telecom, such fickleness would scare away a lot of long-term investors. Such behaviour needs to be kept in strict check if we want to be the preferred destination for foreign capital.