Do Not Chase Gold Now

Gold Prices have increased over 20% in the last few weeks.

 

It is widely believed that gold is the best hedge against inflation. That theory seemed to hold when fear of inflation was at its peak last year. Then why is gold doing so well when the world is staring at the prospect of deflation? The answer lies elsewhere.

 

The stimulus packages worldwide have injected huge amounts of money into the economy. When paper currencies lose their value, hard currencies like gold and silver become attractive.

 

So, the present demand for gold is not coming from consumption for jewellery or industrial applications. It is coming from financial investors. And that is dangerous territory. Financial investors identify asset classes based on fundamentals. But soon all judgment is dropped in the chase that follows. Without realistic upper limits to valuation, bubbles get formed in asset prices.

 

This happened to real estate, equities and commodities in the past few years. We wonder if now it is the turn of the yellow metal.

 

So please be extra cautious if you are planning to buy / invest in Gold at current prices. Remember there is a pin waiting for every bubble.

 

I would like to finish this article with one interesting quote from Warren Buffet on Gold

 

“Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.”

 

(with inputs from Equitymaster)

Why Gold Prices are now Volatile?

One would think that gold would be the safest harbor at this point, with the turmoil in the equity markets across the globe. But, gold has, in fact, proved to be quite volatile itself.

 

It was a few months ago when we saw the price of gold move from around $740 to over $920/ounce. But last week, the price of gold fell below $700/ounce. Yet, after plummeting to its weakest in a year, it bounced back this week on stronger crude prices, a recovery in equities, a firmer euro (against the dollar) and tightness in the physical gold supply.

 

The lure of the yellow metal arises from the perception that it is a safe and alternative investment over times of economic crises and political turmoil. But what is amazing is that this year gold’s trading pattern has been marked by substantial volatility and the prices fall as quickly as they rise.

 

There are a number of reasons for this behaviour.

 

The most eminent is the global nature of the crisis. It is not just the U.S. which is going through an economic downturn, but a global phenomenon including the emerging markets with Western Europe now emerging as the epicenter. As countries globally are dealing with their own economic slowdowns, it is pushing their currencies lower. As this happens, the dollar, despite the current state of the American economy, has been strengthening against its foreign counterparts. As gold trades inversely proportionate to the dollar, any strength in the American currency will result in gold prices dropping.

 

Besides the rise in the dollar, the unwinding of commodity positions, sales of gold to meet margin calls on other assets and selling by hedge funds had resulted in the price of gold falling.

 

But it was best summed up by a dealer in Chicago who was quoted in the press as saying: “The name of the game is to raise dollars. People will sell their winners to fund their losers. The best performer since the financial crisis began has been gold.”

 

So if gold is part of your portfolio, keep holding on to it. Don’t fret at the unnecessary turn of events. Though it may follow an uneven path, the underlying trend is for the yellow metal to rise.

 

(Courtesy: Valueresearch)

 

(Originally drafted and mailed on 1’st Novermber’08)

Gold as an Investment

If you observe, Gold has not been a good investment (in terms of returns) in the last 3 decades. That may change  now because of various global factors. I’ve given below excerpts from an article by Ajit Dayal which explains why Gold has become a good investment now. One may consider investing a part of portfolio in Gold – preferably in Gold ETFs (Exchange Traded Funds) rather than physical gold or Jewellery because of issues of storage, safety and Wealth Tax.

 

“There are 2 places to invest your money- Indian Stock Markets and Gold ! 

 

Buying the basket of stocks that make up the BSE-30 Index in 1980 would have given you a return of 136 times your investment. If you were to average out this return over the 27 year period, that works out to 20% per year every year for these past 27 years.

 

There will be continued economic growth in India over the next decade. This means that Indian companies will continue to grow sales and profits and – because share prices are a function of these growing profits – an investment in shares of Indian companies should generally be a pretty profitable investment.That is why I like the Indian stock markets – even at a 20,000 Index level.

There will be bad years and scary quarters but a disciplined investor can hope to earn reasonable returns in the long term.

 

But there is another great investment opportunity staring us right in the face: gold.

 

That’s right. Buy a lot of gold. Gold is now at around USD 900 per ounce. It was trading at USD 37 in 1971. Gold then shot up to USD 850 in 1980, collapsed all the way to USD 260 in 1999, and has only now crossed the previous peak of USD 850 that it established 27 years ago.

 

I own gold. Now, I am ready to buy some more gold. Just as you should. Why?

 

Because many of the central banks of the world have lost sight of what they are supposed to do.As a student of economics, we were taught that the role of a central bank was to ensure that it maintained the value of the paper currency issued. It did this by ensuring that every time it printed paper, it had a fixed ratio of gold lying in its vaults. But, over the past few decades – and increasingly over the past few years – the central banks have been printing more paper and not worrying about the gold they have as a reserve for their paper currencies. And paper currencies are, in the end, paper. History has shown us that governments have fallen and paper currencies have died with them. Gold has been a currency – a medium of exchange – for centuries. No paper currency has existed for that long. Not the US Dollar. Not the Sterling Pound. Not the Indian Rupee. As governments have printed larger amounts of paper currencies, these currencies have lost value against real assets like property. Or even a samosa.

 

Of Samosas and Gold…

In 1980, it probably cost you Rs 1 to buy one samosa. Today, it costs you Rs 10. Has the samosa become 10 times larger over the past 27 years? Not at all. The fact is that Indian rupee has lost value over the past 27 years so the samosa wallah wants more of your rupee to sell you the same samosa. He wants 10 times the rupees for that same samosa. Or look at the price of your house. In 1980, it cost Rs 200 to buy one square foot of property in Cuffe Parade, Bombay. Today, it costs Rs. 40,000 per square foot. That is an increase of 200 times! Money, obviously, buys less these days. Paper money has lost value. That is what is called “inflation”.

 

Now look at gold. It was USD 850 briefly in 1980 – when samosa was available at Rs. 1 and land in Bombay at Rs 200. Today it is at USD 900. Interesting, isn’t it? The one currency that governments cannot print at will and which has, across civilisations, been a “store of value” – a hedge against inflation in the language of economics – has not really seen any increase in price over the past 27 years.

 

If the price of gold was to move in line with the price of samosas, gold should be trading at USD 9,000 per ounce or over Rs 1 lakh for every 10 grammes. But gold can be bought for around Rs. 11,000 for every 10 grammes today. If gold was to have moved along with the price of Bombay property, gold should be trading at Rs. 20 lakhs for every 10 grammes.

 

That may sound absurd. But sometimes the most attractive investment opportunities are those that sound absurd. Like Infosys at its IPO in 1992 or Zee at its IPO in 1993. You could have multiplied your money by over 1,000 times in each of them.

 

Don’t get me wrong – not every absurd idea is a good investment.

And not every investment will increase in value by 10 times let alone by 1,000 times. But, sometimes, simple logic and harsh facts should allow us to make simple investment decisions. Do I expect the price of a samosa to fall to Rs. 1 – because that price for a samosa, justifies the fact that the price of gold has not moved in 27 years? Do I expect the price of Bombay property to fall to Rs. 200 per square foot? Or do I expect gold to start climbing and get closer to the equivalent price of a samosa and the price of Bombay property?

 

Inflation and uncertainty require insurance. Gold is an insurance against absurd government policies – worldwide. I own gold.  To diversify my portfolio. To spread my risks. You should consider investing in the Gold Funds (open-ended ETFs). Unless you believe that your next samosa will cost you Rs. 1.”

 

(Courtesy: Equitymaster)

 

(This article was originally drafted and mailed on 31’st January 2008)