It is Diwali time and gold, the eternal favourite, is no wonder the in-thing. Investors in gold have a strong reason to be happy. The yellow metal has once again generated attractive return.

Since Diwali 2010, gold has outperformed many other commodities and asset classes with returns of nearly 24 per cent in dollar terms and close to 30 per cent in rupee terms.

The last few weeks have been challenging for the precious metal, though. From the July highs of over $1,900 an ounce, gold fell to $1,550 an oz in September for a variety of reasons including risk aversion, need for liquidity, technical selling, increased volatility and margin hikes. Currently, in the global market gold is trading around $1,640/oz.

What has the price decline of last four weeks done to gold? It has certainly generated greater interest in the physical market. Asian demand — China, India — for the metal has increased for sure. At every price dip, there are buyers. So, physical demand is currently cushioning the downside.

Because gold has produced attractive returns, investors are wondering whether similar returns will be seen in the next 12 months. As prices have kept escalating in the last 10 years, there is expectation that the price would rise further.

What's the gold price outlook from Diwali 2011 to Diwali 2012?

Although from a fundamental perspective gold market is in physical surplus, prices seldom move on the basis of physical demand and supply. Non-fundamental factors are greater drivers of gold prices.

However, even from a fundamental perspective, the sentiment in the market has undergone a change in the last two years. The official sector appetite for gold is healthy. There is more central bank purchase than central bank sales. While European central bank sales have dwindled in volumes, from time to time central banks of many emerging economies buy gold for various reasons including asset diversification. In addition, coin sales have turned robust.

On the other hand, the global macroeconomic picture is far from inspiring.

Weakened confidence in growth prospects, unresolved European sovereign debt crisis, unabated geopolitical tensions, easy-money policy, low interest rates and creeping inflationary expectations have all combined to create a gold positive environment.

Gold is most likely to reassert its position and provide further evidence — if one was needed — over the coming months that it is both safe haven investment and hedge against inflation. Although risk aversion and need for liquidity may put some downward pressure in the immediate future, gold enjoys the potential for a rebound in prices.

The most likely scenario is for the metal to gradually move up and test $2,000 an ounce early next year. But the road to gaining almost a quarter in value from the present levels will surely be bumpy. There will be profit taking, there will be price correction and there will be volatility.

In sum, while in the near-term the precious metal could be stuck in range-trading, the medium-term outlook for gold is bullish. In rupee terms, the asset can potentially reach Rs 28,500 for 10 grams in the coming months.

To profit from the potential price escalation, it is important to have an exit strategy in place.

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