Saturday, March 3, 2012

Gold : Is it really safe anymore???

It has been said that gold is the safest currency. That is the reason that if there is any uncertainty in any part of the world gold prices shoot up.We have always considered gold as hedge against inflation and that might be the reason that historically gold prices have moved in tandem with inflation.But in last few years it has broken all its records.

With the modern reality of gold as a speculative financial investment. Gradually, over the last two decades the tradability and liquidity of gold in a paper, financialised form has completely overtaken everything else.This is not the same gold but another speculative asset class which moves up and down depending on liquidity. 

The days are not far when we can see the deepest fall in gold prices which we Indians have never experienced in past.

In a recent article ‘Why stocks beat gold and bonds’ that Warren Buffett wrote last week briefed certain facts about gold.

Buffett explains that Gold belongs to a class of investments that will never produce anything, but whose growing value depends entirely on the belief that someone else will pay more for it eventually. The value of gold has been driven by the fear that other asset classes will lose value and this has driven up the relative value of gold. The only thing that motivates gold investors is that in the future, investors will grow more and more fearful in this manner. As more and more investors come to believe this, their increasing belief appears to confirm the truth of the belief itself for a while. Eventually, the bubble bursts at some point when the supply eventually exceeds the rate at which the belief is growing.

As Buffett points out, in gold’s case, there’s the additional problem of supply. At current prices, the world produces 168 billion US dollars of gold every year. Not just that, it is in the interest of the producers to dig up as much of the stuff as possible while prices are high and rising. The continued rise of gold would require at least that much fresh money flowing into gold investment every year. That’s a pretty large inflow that will have to be kept up if prices are to sustain. It’s true that Indians are at the forefront of the efforts to sustain this. We appear to absorb an amazing 30 per cent of fresh production every year, and thereby do huge damage to the country’s current account balance.

Back home in India the biggest problem our government of High current account deficit is also a result of our love for this asset. On the current account deficit (CAD), analysis of the current & capital accounts throws up the following: 

Gold and silver imports stood at 10.1% of commodity-wise imports in FY11, lower than only petroleum products (30.1%) and capital goods (20.3%). For FY11, India’s current account deficit stood at $44.2bn, (-2.6% of GDP), the highest in last 4 years. Gold and silver imports were $38.5bn, nearly 87% of the absolute CAD of FY11. Minus gold imports, CAD was very low at -0.4%. 

As an investor It would mere foolishness to consider that total gold assets of the world till date of $9.6 Trillion (At a price of $1750/Ounce) can replace global economy of approx.$200.00 Trillion. 

At one point in time world would agree for some alternate ways for valuing currency, and reduce dependency on Gold.

As an financial planner I feel gold can't be ignored as an investment class, but should be limited to the %age of Security or liquidity required at any given point in time plus additional requirement for child's marriage or personal consumption.