Gold: The party’s over

The Indian price of gold has risen sixfold in the last decade, fuelling a record speculative import spree. Soaring gold imports have hit $42 billion in the first ten months of 2012-13 , pushing the current account deficit to near-disaster levels. The finance minister is wringing his hands in distress, while housewives say that buying gold was the best thing they ever did.

Sorry, but the party is over. The notion that gold is the finest investment, whose value can only go up, is dead wrong. History shows that gold fluctuates crazily, so it can look a fabulous investment for some time and then become a total disaster. There’s nothing safe about it.

The Indian price reached a peak of Rs 33,000 per 10gm in late 2011. It has since fallen steadily to just Rs 29,000. Global trends suggest we have entered an era of falling or stagnant gold prices. Housewives and all other buyers beware: gold will probably be a lousy investment in the next decade.

After the US went off the gold standard in 1971, gold shot up from $35/ounce to $835 in 1980. It looked the best investment in sight. But then its price crashed and stayed down till 2001, at around just $250/ounce. Gold investors lost their shirts (and sometimes underpants) for two decades.

However, after 2003 gold zoomed again. It reached a new peak of $1,890 in late 2011. But it has fallen steeply to just $1,501 last Friday. It may bounce back temporarily , but will then fall again.

The fall in price has been less dramatic in India because the rupee has depreciated against the dollar. Even so, gold in rupee terms is down 10% from its peak. Goldman Sachs estimates that the world price will fall sharply to $1,270 by the end of 2014, and other analysts are almost as gloomy.

Gold is a safe haven to which people rush in troubled times, so speculators hoped its price would rise in today’s troubled conditions. North Korea is threatening nuclear war and Japan seeks to double its money supply. Cyprus has set a dangerous precedent by confiscating uninsured large deposits in its top banks, and this could have prompted a rush into gold. Why, then, has gold fallen instead of rising?

First, fears of a Eurozone breakdown took gold to a peak in 2011, but those fears are mostly gone, so gold is less needed as a safe haven. Second, the US is finally set, after five years, to end its quantitative easing of money supply, reducing the monetary fuel of speculators.

Third, as part of its bail-out package, Cyprus may have to sell its gold reserves to raise 400 million euros. Not only will this glut the market, it stokes fears that similar gold sales may be forced on other troubled Eurozone countries that may also go bust. Troubled Italy has the fourth largest gold holdings in the world of 2,452 tonnes, worth a whopping $95 billion.

Speculators had poured $26 billion into gold-linked securities in 2010 and 2011. But after mid-2012 , when fears of the Eurozone’s survival ended, many speculators (including George Soros, the most famous of all) decided that the gold boom was over and got out of the market. Money fled from gold-linked securities. SPDR Gold Shares, the biggest exchange traded fund linked to gold, has seen net redemptions of $7.7 billion in 2013 so far.

Indian speculators and housewives, please read the writing on the wall. The special reasons driving the gold boom of the last decade have gone. It’s time to sell gold, not buy.

To discourage gold imports, the finance ministry has increased the import duty on gold. Unfortunately this has raised the domestic price correspondingly, rewarding instead of penalizing speculators. It has also led to increased smuggling.

In decrying and trying to suppress gold imports, the finance ministry has unwittingly given the impression that gold is a great bet. Moreover, government banks today are aggressively pushing sales of gold coins to customers as a must-have investment. They should be obliged to warn customers of the risks too.

The finance minister should warn people, in speech after speech, that gold has already fallen a lot and is likely to fall much further. Every time the gold price falls, he should come out with advertisements saying “I told you so”.

Last but not least, he should announce that the import duty on gold will be abolished by the end of the financial year. This will induce people to stop importing now, and wait for next year, by which time speculation may be ebbing anyway. The balance of payments will improve magically.

4 thoughts on “Gold: The party’s over

  • 2013.May.11 at 22:33
    Permalink

    I believe that the economics behind buying gold in India defies all odds. Buying of Gold in India takes places for it is not only treated as a hedge against inflation but also holds value in our culture. People buy gold irrespective of the prices – it serves a double purpose. Even if prices were to fall down sharply, people will still buy gold because of its significance in our culture.
    Regarding the point of presenting gold as a bad investment with the suggestions of removing import duty and going to the extent of saying that prices will fall down further, i believe it would lead to distress selling and would be a form of an institutionalized scam – deliberately making people sell their gold. It would also have a serious repercussion for the NBFCs whose primary business source are gold loans. Reports are that they have already been flouting the RBI guidelines of maintaining a Loan to Value (LTV) ratio of 60% and have offered loans for upto an LTV of ~75-78%. A deliberate projection that prices will further fall will lead to people not paying back their loans for it would make them believe that the loan they are trying to repay to get back their gold is much more than the actual value of the gold itself – this is similar to whan happened in the sub prime mortgage crisis in US where people defaulted on their loan payments for their houses for the loan amounts had exceeded the then present day value of their property.
    The government should keep an eye on the developments in the in the international market regarding falling of gold prices, and if they actually fall sharply, the government should step in to keep the sharp fall of prices in check in the domestic market so that the NBFCs do not go bust. Its time for a role reversal. Governments till date used to keep in check the sharp increase in prices of commodities by regulation, but gold in the present scenario demands a reversed strategy – regulating a sharp fall in the prices of gold in the domestic market.

    Reply
  • 2013.Apr.22 at 16:16
    Permalink

    Its a good article.I come to know about the present situation of gold.Can anyone suggest me when to buy some gold,If it is not the correct timing.

    Reply
  • 2013.Apr.22 at 00:09
    Permalink

    I hope Mr. Iyer’s Mantra will work and his advice will be well taken by the Gold-chasers and the Govt; Let us wait and see.

    Reply
  • 2013.Apr.20 at 18:56
    Permalink

    Very interesting perspective…thank you sir…

    Reply

What do you think?