Gold – can you trust the government and the RBI?

Gold biscuitGold is increasingly coming under attack from politicians and central banks. Recent statements are disturbing. As is normal, politicians and central banks like to create imaginary devils to distract citizens from root causes. To explain our high current account deficit, gold is the new devil.

Chidambaram talks about the need to curb gold imports

“Demand for gold must be moderated… We may be left with no choice but to make it a little more expensive to import gold. The matter is under government consideration”

or the completely absurd,

The country, the minister said, “cannot afford to spend so much on importing gold. Nobody says gold within the country should not be used for whatever purpose. There is enough gold within the country. But import of gold is huge strain on the current account”

If existing holders of gold in the country don’t want to part with their physical gold, fresh buyers will cause imports to rise. What is wrong with that?

Here is the complete article at ToI.

The reality is that there have been negative real interest rates. After subtracting on-the-ground inflation which seems higher than the CPI figures that the government publishes, at least to me, you are left with nothing on debt investments.

ULIPs have been a failure and a big reason for mistrust in the financial system. The IRDA, which is the insurance sector regulator, seems to have been sleeping at the wheel, when insurance companies were introducing patently bad products from a consumer perspective.

There is manipulation in the stock market.

The common man is left with gold and land not because they are necessarily the best, but because all the other options are dangerous minefields from his perspective.

If the government wants to reduce India’s fascination for gold it has to make alternatives simpler, cleaner and most importantly, financially worthwhile.

But wait, this is still not half as dangerous as what the RBI is proposing.

RBI is talking of replacing physical gold by paper gold

Some suggestions given by RBI are as follows:

  • Gold Exchange Traded Funds (ETF) may be allowed to invest in gold certificates with banks
  • Underlying physical gold in ETFs may be loaned out in the market

Today, if you read through the ETF information documents on a mutual fund website you will find that they are supposed to invest in physical gold of a said purity. Tomorow, this might change. For the first suggestion, I will simply say that the job of a gold ETF is to invest in physical gold and give investors a tracked price. Gold certificates add another layer of paper. How do you protect against default on these certificates?

Take the second suggestion. Gold once loaned out, may not come back and cause liquidity issues in the gold ETF. I will elaborate. A gold ETF may loan physical gold to another entity in the market. If there is a liquidity crunch like in 2008, the entity may face trouble in returning this gold. One more scenario can be that the first entity may have lent this gold further down in the market. A second entity might not return gold to the first entity which in turn cannot return gold back to the ETF.

There are serious systemic problems in both the suggestions with capital loss risks to the ETF unit holders. Read the complete Business Standard article here.

Both the government and central bank are becoming increasingly desperate respectively

I have written about gold in an earlier article on government finances. Do read it and you will appreciate why I stress this point so much.

I had also mentioned gold confiscation in the USA during the Great Depression, in an earlier article.

Capital controls, restrictions on bank transfers and withdrawals, are not unbelievable if India’s finances deteriorate. In such a situation gold might also come under the cross-hairs.

It might be wise to increase the proportion of physical gold in your total gold holding. Gold ETFs might not be safe in an extreme situation.

There are tax implications which are negatives. On the other hand physical gold is least affected by possible government and central bank interventions. It is a personal call. It also depends on whether you trust the government to act in your best interest or its interest. These interests are usually different!

Please read the disclaimer as always.

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  1. Hemant says

    I feel govt is at one end & you are on other hand ,while the truth is somewhere in between(Though more towards your side).There are several problems in holding gold in physical form,including taxation.Further regarding stock market problems ,the moneylife write up ,you were referring ,mentioned about all junk stocks,which no prudent investor will go for.Yes we need better financial system but till then we have to take care .

  2. says

    Hi Hemant,
    I agree with you on the prudent investor part. But there are people who are beginners who put money into the market on the basis of tips etc. I am not defending this behaviour. It is foolish to do so. But the point is that these manipulations should not exist. Nor should action against erring companies take time. Nor should penalties be small. What action really has been taken against Ketan Parekh? There are enough reports that suggest that he still operates through benami means. The fact is that there are manipulations not only in junk stocks but in the top 500 stocks which is disturbing.

    On the physical gold question, I hope it never comes to that. I first think about protection of capital and that motivates my actions. I agree my view might be at the other end of the spectrum as you say. But the last crisis has taught us one thing. When a government wants to do something it will do it irrespective of whether its good or bad. I don’t want to be in the way if it does. You are right. There are higher costs involved. Wealth tax consideration too. One will need to decide for oneself, the tradeoff between these costs and the probability of a bad event.

    Thanks for sharing your view.

  3. Uma says

    If Rupee keeps crashing people will flock to gold. First control your note printing presses and clean up the bad assets in PSU banks

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