Tuesday, May 14, 2013

Gold - The metal in hearts of every Indian

It is a belief that gold is hedge against inflation. It is a safe haven investment in a mismanaged world. Let us understand myths & facts of gold that will clear your mind.

The current options for Indian investors to buy Gold is; Jewellery, Gold Coins, ETFs or Gold Savings Funds of Mutual Funds. All was going good till the morning of mid April 2013 when the gold prices suddenly saw a fall of nearly 12% in dollar terms.

Commodities (including Gold), Real Estate and Equity run on cyclical movement. Any of this traded at hype will suffer periodic bursts of sharp rise and bouts of steep decline.

The buyer of gold has theory in his mind. Investors buy gold because of the ‘greater fool theory’ (the next guy will buy it at a higher price). The second popular belief is that gold prices are supposed to rise, as it had always happened in the history too.

It is a general belief that Gold is a hedge against inflation.
Looking at the historical prices of gold and consumer price inflation, In the 1980s, inflation in the US was around 6%, and gold lost more than half its value. This myth of gold being a hedge against inflation has been bunked by researchers many times in the past.
What is fair value of Gold?
At Rs. 27,000/10gm, gold is higher or lower than the ‘fair value’? Gold does not generate income. It does not pay dividends. A good business generates profits, a property generates rent and a bond generates interest income. Since gold does not generate any return of its own, it can only be new buyers with expectation of gold price to go up. This is just a speculative approach.
So, what really drives gold prices?
Money and commodities are moving around the world with improved technology in the financial interconnected world. 
  1. Gold is priced in US dollars. Gold prices will go up, if the dollar is weak. 
  2. The price of gold is measured in rupees in India. If the rupee is weak against the dollar, the price of gold will go up to that extent.
Indians don’t remember gold prices crashed from a high of $ 850/ounce in 1981 to $ 250/ounce in 2001 over 20 years. In 1981, Exchange rate was $1/Rs. Rs. 8; in 2011 it became Rs. 45 now around Rs. 54. Weakness of the Indian currency pushes the price of gold up. The economic mismanagement in India is remained favorable to gold buyers.

Gold in Indian Context:

In India, Gold has monetary value and social value too. Showcasing ownership of quantity of Gold is a proud statement in Society. Gifting Gold in family celebration is a must custom. Why Indians are so close to gold? While looking back to history of 400/500 years back, United India has always been attacked by outsiders like Aryas, Sikander, Taimur, Allaudin Khilji, Portuguese, Dutch, English and many more. During war, people required to run away with handy wealth (gold) to other places. This insecurity has developed a social custom of possession of Gold. This still remains in the mind of every Indian, every corner of India.

In fact, buying gold is buying fear. So whenever fear is high, the gold will outperform. The fear may be war, currency weakness, economical uncertainties, countries at risk and lot more. More the fear, high the prices will be.

Those who have cash on hand prefer to buy gold as investment. That seems a simple statement but holds too much quantitative importance.