Pay no attention to Chidambaram when he speaks against gold

Anti-gold statements

P ChidambaramSource: Wikipedia

More and more households should be encouraged to save in financial instruments rather than in gold.

- P. Chidambaram, Finance Minister, 16 Aug 2012

And today, he got support from the industry.

The government is planning and CII is fully supportive of
better incentive for investment in mutual funds and equity so that people do not invest that much money in gold which could also help in improving balance of trade.

- Adi Godrej, Confederation of Indian Industry (CII) president, 28 Aug 2012

Why is gold considered an investment option?

As I explained in an earlier article injecting money supply into the economy without corresponding increase in actual goods and services is a recipe for price inflation in subsequent years.

The US and the Eurozone have seen huge increases in money supply over the last few years. All of it may have not entered the economy but its a looming danger. With global linkages money flows into other countries too.

These are some facts about gold.

  • Gold has played the role of money in the past in economies around the world.
  • It is considered a store of value by millions of people around the world
  • Gold is a real asset which is limited in supply.
  • Gold cannot be printed out of thin air, hence cannot be debased unlike rupees and dollars which can be printed by governments.

Gold is reacting to the loose monetary actions of governments around the world.

Here is what Kyle Bass, Founder of Hayman Capital, a hedge fund, has to say. Move the pointer to 1:30 to hear him speak about gold.

 

Buying gold is just buying a put against the idiocy of the political cycle

- Kyle Bass, Hayman Capital

You might not be familiar with the word “put” in his statement. Here, think of it as having the meaning of  “insurance”.

How has gold fared as an investment in India?

As I explained in the last article, investment returns should be judged against inflation over the considered period.

The blue line in the chart below shows the price of gold in Mumbai per 10 gm from 1983-84 to 2011-12. The red line is Inflation (IW). IW stands for industrial workers. The green line is the investment returns  on fixed deposits (FD) assuming that every year a person invests in a FD which matures in 1 year and then re-invests it in a fixed deposit of 1 year and so on. The interest rates are taken as per Reserve Bank of India (RBI) data. The three data series are all indexed to 100 in the initial year.

Gold and fixed deposit investment compared to inflation in IndiaSource: RBI Data, Capital Orbit

Over the long-term gold has beaten fixed deposits which in turn have beaten inflation. Especially in the last 5 years gold investment in India has given high gains.

  • India is lucky to have the concept of gold as savings ingrained in our culture.
  • Even an illiterate person in India knows the importance of gold as a store of value.
  • Gold has served well against profligate governments including the Government of India.

What happened between 1998 and 2006

You will see that for a period in between 1998 and 2006 you can see under-performance of gold vs. inflation. You might ask how gold is a good investment if it did not beat inflation over this period.

There is a reason. India had high gold duties in the period before liberalization in 1991. This also was a big factor behind the high prices of gold in India as compared to international prices. And it was one of the biggest reasons of gold smuggling into India during the 80′s.

The difference in price between Mumbai and London prices was greater than 30% through most of the 80′s. In 1992-93 it decreased to 19%, to 13% in 1998 and to 5% in 2002-03 respectively.

It means that all the buyers of gold in India till 2002-03 overpaid for their gold purchases by a fair extent in comparison to the international price. That would deflate returns to that extent in the coming years when Indian prices moved closer to international prices. For example, in the last 10 years the difference between them is hardly 1-3%.

So all things considered, which include government meddling in prices, gold has been a inflation-beating investment in India but only when held for the long-term.

Potential for gold in the future

  • Gold prices should react by going higher if there is further quantitative easing or money printing by governments around the world
  • Gold should also go higher if there are increased central bank gold purchases.
  • India is a large gold consuming country and volume demand has slackened. Track developments in India closely.
  • A small exposure to gold may be wise. But this should be money for which you do not have immediate need in the coming 3-5 years. It should be long-term.
  • Gold investments in India can be via
    • Physical gold – Coins, jewellery
    • Gold Exchange Traded Funds (ETF)
    • Gold Saving funds (these funds will be covered in a later article at Capital Orbit)

What about Chidambaram?

I would rather trust the money supply numbers released by the RBI and see the government’s intention to curb the fiscal deficit. I will also look at global developments closely.

I too am holding on to my gold as a protection against government stupidity as Kyle Bass said.

 

I urge you to read the disclaimer.

Interesting links:

  1. Capital Orbit research – Gold (in London prices) and fixed deposit investment compared to inflation in India – Source (RBI data)
  2. Wall Street Journal blog article on gold smuggling in India
  3. Read page 4 of this PDF – Gold in the Indian Economic System – Y.V.Reddy

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Comments

    • says

      Thanks Rajesh. Glad you found it useful.

      The funny thing is that if you talk to your parents, they would not indeed this explanation. They have “folk wisdom” and have been following it since forever.

  1. Gunasegaran says

    Hi….Kunal

    The article is very informative and practical, i would like to touch base with you to get to know you better. I am a Licensed Financial Planner based in Malaysia, my contact number is 0125084578, or we could skpe?

    Thank You

  2. Vishal Srivastava says

    Nice article Kunal. I believe in gold…. In my opinion gold is a promising asset but few questions… answers to which I don’t know :) – as the Indian market opens up (hopefully it does), how will the gold prices react. Will the global economic situation affect them? Secondly, how is Indian market going to do in next few years. The long-term prospects are promising as more skilled labor enters the workforce. Thirdly, a lot of personal investment companies are opening shops in India and the capital market is slowly maturing. Will this lead to a higher availability of other investing options? If someone has a portfolio of stocks (say risky assets) or market index funds, I am wondering would it make sense to hedge the risk by investing in gold, or other commodities? commodities are still not a risk-free asset. Would love to see the market and commodities correlation.

  3. Vishal Srivastava says

    yeah I should have been more clear – in the first line by mentioning market, I implied that if the import tariff are lowered, the price of gold in India would correlate more closely with the international prices.

    I concur that it is a good way to protect against inflation. I was just thinking on a different tangent – basically what role does gold (or commodities) play in your portfolio if you want to reduce risk. I will think about this more and check out the links and post my thought… this seems pretty interesting.

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