Friday, 17 May 2013

The Gold Scenario

Causes of fall, Relevance for consumers and investors

The recent downfall in the gold prices has taken everyone by surprise. People are obsessed with gold either due to its significance in their portfolio or the importance it holds in their daily life (wedding gifts). Although non investors are not so much concerned with the gold prices and welcome the price fall, but there is a certain class of investors that use gold for hedging against growing inflation. The yellow metal is considered as a safe metal having stable value that is immune to inflation. Seemingly on one hand there are investors who are not sure about what to do with their gold investments and on the other hand there are other people who are wondering whether there is an opportunity to buy gold at current prices and take its advantage. Post the global financial meltdown in 2008, the belief in gold as safe haven increased but the current slash in the gold prices has lead to an ambiguous situation where it has become difficult to predict the future behaviour of gold prices and consequently its value.
There are certain factors that are responsible for plunging gold prices. Since gold prices in Indian markets move in tandem with international gold prices, so, any change in international prices would directly affect the domestic prices of gold. One of the most important issue that has been the main cause for tumbling of gold prices is that of global inflation, which is falling, thereby reducing gold’s value as a hedge against rising prices. In addition to it there has been a considerable amount of selling of gold exchange-traded funds, which has forced ETF managers to sell their physical bullion. It has temporarily added supply to the market which has pushed the gold’s prices down. Further there has been an increase in speculative short positions for gold futures on the COMEX (commodity exchange), accompanied by a decrease in speculative long positions. Continuing with the reasons responsible for the falling prices of gold, the Cypriot central bank’s need to sell off some its gold reserves to pay for its bailout also played its role in diminishing the gold prices. Improving economy in the US has also led to the belief that gold needs not be held as a hedge. The recent fall in the gold prices has been considered to be the largest decline in gold prices in the last thirty years.
Now getting a fair idea of how the gold prices decreased, it becomes compulsory to know about the relevance of the decreasing price on the two sections of retail consumers: Individuals buying gold for consumption purposes and individuals buying gold for investment purposes. Those who purchase gold for consumption purposes are delighted by the falling prices. The plunge has prompted a rush in physical gold purchases across India, and across all sections of the society. This is not surprising as India is the largest consumer of gold in the world with an annual consumption of 963 tonnes (in 2010) and accounts for 31.5 per cent of the world gold consumption. Of the total demand, around 77 per cent is in the form of jewellery. Consumers view this fall as an opportunity to augment more of the yellow metal. The next class of retail individuals, who purchase gold for investment purposes are in a state of ambiguity as they are unable to decide whether they should keep their investments or is there any need to sell them or buy more. Gold as an investment has a lot to offer to the investors. It has a negative correlation with other preferred asset classes. Secondly, gold is both a commodity as well as currency, so, the sources for its demand are far more diverse. Investment channels such as jewellery, coins, gold ETFs and e-gold also make liquidity risk very low. Investing in gold doesn’t carry credit risk. Offering such benefits to the investors is not the only side to look for, but there is another face of the same coin which might place investors in trouble. They might have to face the risk of price fluctuation, as it is inevitable but the volatility can be tackled by investing systematically as well as by choosing the right way to invest in the gold. Ideally, the exposure to gold should not be more than 10 percent of the portfolio at all times. Keeping in view the benefits that gold investment is offering them, it has become difficult for them to reach to an amiable decision.
The key deciding factor should be the likely contribution of an investment decision to the long term prospect of the portfolio. Gold has a lot to offer to serious long term investors. Regardless of the current decrease in the price of gold, it is a better long term asset. Further the increase in physical gold is a clear indication that common man still holds this asset in great value. Gold is a good hedge and should be held to some extent in every one’s investment portfolio from the point of view of diversification, especially in times of uncertainty. All investors who have been quite disciplined in investing in gold as a part of their asset allocation process would do well to not only hold on their investment in gold but also continue investing systematically through their defined time horizon. Investors need to park a limited amount of wealth under gold. Investing in gold is a wise decision but in a limited amount. Anyone who may be planning of taking advantage of the steep fall in gold prices should remember that such decisions rebound sometimes. So, analyzing the risk factors associated is extremely important before such a course of action.

The writer has done a project “Gold Trading as a Profitable Business Proportion for Banks and NBFCs (Non banking financial companies)” under the guidance of Respected Mr. Anoop Mohanty (Asstt. Professor) at Lovely Professional University, Punjab

Syed Maajid Rashid Andrabi
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