Home > Investing in gold - is that an investment?

Investing in gold - is that an investment?

' "Future traders" in the gold market in Mumbai had a chance to book profits of an amazing level. Translated on a P.A. basis this figure is 150%. And trading in MCX gold futures crossed Rs 10,000 crore during the period and daily volumes touched a new peak of Rs 2357.25 crore'. This was a report in a leading financial newspaper recently. Gold has now to be looked at in a different light, not from just under the jeweller's yellow light in the showcase. It is increasingly becoming a serious investment option.

Gold as money

Is gold money? It is rare and has been prized long before the concept of "money" was ever discovered. For nearly three thousand years (since the first gold coins were struck in Lydia in 700 BC), gold's primary utility has been recognised as a medium of exchange. Marco Polo brought to the West the first stories of paper money, introduced by Kublai Khan and made from the bark of the mulberry tree. Bankers, who were originally goldsmiths who stored gold for other people and charged a fee for their services, began to issue paper "receipts" for the gold stored. As these receipts became more widely acceptable in exchange, the idea of "paper money" was introduced.

The history of gold as money in modern coin form spans 2630 years, from 700 BC to about 1930 AD. The last official tie between gold and a circulating currency - which also happened to be the world's "Reserve Currency" - the currency held by all other nations as the reserve behind their own currencies, was broken on August 15, 1971. The world entered the first era in its history in which no circulating paper anywhere was redeemable in gold by anyone. The result has been the financial system of our times - the "floating currency" system.

From money to investment

Since ancient times, gold has been the most favoured investment option. Investment in land came second. Later, more and more people started investing in stocks and securities. In fact, the term used to persuade (or con) people to invest in stocks and securities was Gilt Edged security. (At times, the share certificates were actually covered with a thin edge of gold!) How has gold performed as an investment? It will be practically impossible to compare it with investment in land. The analysis will get very subjective, as no known benchmarking is available. However, one can compare gold as an investment against stocks by looking at Dow Jones and our own Sensex.

Dow-Jones Index and Gold

Until mid-1954, the all-time high for the Dow was 381.17, set on Tuesday, September 3, 1929. In February 1966, the index reached a high of 995. That was the Dow's first trip to the 1000 level. It reached it in late 1968, and it actually broke through it (barely) in early 1973, mid 1976, and mid- 1981. But the Dow did not decisively breach that 1000 level until the beginning of 1983.

By comparison, this is how gold fared in that market.

Up until 1934, the "official" gold price was set at $US 20.67. From 1934 until 1971, the "official" price was $US 35.00. Gold did not reach $US 300 an ounce until July 1979. But once gold breached that $US 300 level, it never dropped below it for long. Just as the 1000 level had stopped the Dow for 17 years (1966-'82), the $US 300 level supported gold for 18 years (1979-'97).

But it should not be forgotten that when gold prices went up during the late 1970s, it was just trying to catch up with prices of other things that had already gone up. In 1970, when the price of gold was $35 an ounce (due to the gold standard then followed in USA), it was unquestionably undervalued. When gold hit $850 an ounce in January 1980, it was again, unquestionably, overvalued. If the increase in gold price had kept the same pace in 1980s and 1990s as it did in 1970s, it would have become $20,000 an ounce by 2000.

Another way of looking at it is that a $10,000 investment in gold bullion in 2000 would have grown to $15,589 by 11/30/04 - a whopping 55.89% increase. That same $10,000 investment in stocks of the Dow Jones Wilshire 5000 composite index would have decreased to $8,971.

How much gold does India have?

India has been a traditional gold-hoarder. We love our gold.

In 2003, India's stock of gold of about 9000 tonnes was valued at Rs. 450,000 crore. (Perhaps, an indication of the amount of black money in the country.) Legal imports of about 500 tonnes of gold in 1998-99 were valued at about Rs. 20,000 crore. In comparison, India's trade deficit that year was only around Rs. 15,000 crore. Today, India imports gold more than any other commodity. Translate this for a reality check; look at the figure of Rs 40 thousand crore every year!

Gold smuggling into India was rampant as the gold price in India has been historically higher than the international parity price. For example, on 27 April 1990, the price of gold (10 gm) in Bombay was Rs. 3,400, whereas the New York price was only Rs. 2,065. In other words, the Indian price of gold was nearly 65% higher. The present figures are no less astounding. India has the largest demand for gold (estimated 780 to 820 tonnes a year) accounting for nearly a quarter of the world's demand. Our consumption rose by more than 45% last fiscal year.

Now, a study of this chart would lead one to believe that it is better to invest in stocks than in gold. But this does not seem to be in consonance with what's happening in the other markets, as seen in the study of Dow index and Gold prices. One possible explanation could be that in the last few years the Indian equity market is undergoing what is termed as 'country re-rating'. Major foreign fund managers are looking at Indian Stock exchange as one that holds a fast growth and returns potential. This is supported by the fact that a major buying of our equities are by way of foreign funds coming in. At the same time, the gold market is undergoing a re-assessment as an avenue for asset funds allocation.

The question then boils down to whether investment in Gold is to be viewed as a short-term prospect or a long-term prospect.

One study, by Pan African Investment and Research Services - a Paris-based financial service - suggests that gold could rise up to US $600 and above by mid 2006 (as compared to the mid-Dec 2005 price of around US $500). Briefly, this is based on the trends of increased purchases by China, and India. Add to this the fact that the high oil prices have flushed the mid-eastern markets with money, which traditionally is not put into banks for 'interest earnings', and hence it sees gold as a good investment. This is also inflamed by the big decline in the world wide gold production and the higher cost of exploring and creating fresh mining prospects.

Will this bubble burst? Well, at these prices, the interest in fresh investments for producing is heating up. India is one such destination, with top investment bankers from UK, Canada and India showing interest. But this is not an immediate pin which can burst this bubble. If the various central banks of countries holding large gold reserves think of encashing on this heated market, and sell part of their reserves, there will be a sudden shift in the equation of demand and supply in one stroke and, then, the market will take a beating.


Some historic gold prices:

As On March	Prices Rs. Per 10 Gms Of Gold.
1925	18
1980	1330
1990	3200
2000	4395

YEAR:	1/1/00	12/31/00	12/31/01	12/31/02	12/31/03	11/30/04
Gold	$10,000	$9,374	$9,507	$11,784	$14,346	$15,589
(London gold price from the London Bullion Market Association)
Stock Market	$10,000	$8,910	$7,391	$6,277	$8,265	$8,971
(Dow Jones Wilshire 5000 composite index) www.wilshire.com

A very interesting comparison with the Sensex:

Time Frame	GOLD - Grew by	SENSEX- Grew by
Over the past 5 Years	About 12 %	Around 18 %
Over the past 3 Years	11.7 % P.A.	40 % P.A.
Over the past 12 Months	25 %. Closing around 7940 on Dec 15th 2005	40 %. Closing at 9170 on Dec 15th 2005