INVESTING IN GOLD ? READ THIS

Gold is generally, and truly so, considered as insurance against risk or as a useful tool to hedge against risk. People say, when all else is lost, gold still remains. Gold goes in the last because of its possessiveness. While some would claim that gold was never a hedging tool or a safe investment, one should also keep in mind that all investments come with some risk. Risk free investment is in effect not an investment at all. That's why we have bank deposits.

India is the world's biggest consumer of gold (followed by China) and its appetite for gold is amazing. Unlike other hungers, it grows with every consumption –something where the fundamental law of economics – law of diminishing returns also fails.

According to one estimate, Indian households alone holds gold wroth over Rs. 70 lakh crores. The fundamental reason for buying gold and jewellery is deep rooted in Indian culture itself, besides being considered auspicious for weddings etc. Besides, Indian peasants are also gold obsessed to a large extent.

Gold prices have fallen to about Rs. 25000 per 10 gram from its peak of Rs. 32500 per 10 gram in 2012 but seem to be stabilizing around Rs. 26,000 per 10 gram. The developments in euro zone economies (selling of gold to protect some economies from being bankrupt) also impacted the gold prices internationally. However, this has shaken the investor confidence.

 Gold prices at a Glance (per 10 grams)

With the recent fall of about 8 -10 percent prices of bullion (in 10 days), the yellow metal has lost its reputation of being a safe investment option. Never before, any of us has witnessed such fall in gold prices as also such erratic volatility of rise and full in gold prices in last two decades. Not alone gold but all precious metals suffered the sharp decline in prices – silver copper, nickel etc. Those who took long positions or would have speculated have suffered in present price fall.

It the Indian and china economy grow this fiscal as is expected, investment and buying in gold may strengthen, irrespective of fall or rise in prices. However, any further sharp fall in prices may put a break on investment, but not on consumption.  Will the current price fall see a decline in demand ? Scared investors may say yes but going by consumer demand, it may even see a surge in demand for gold as has been witnessed post price fall.

On domestic front, there is a lean season ahead, so far as gold / silver are concerned. The demand for jewellery for upcoming wedding season has already been met and fresh investment decisions would also depend on the monsoon predictions which are not available as of now. If the rural economy picks up and incomes grow, rural gold demand may also pick up.

The trend looks to be bearish only with overall selling pressure everywhere. However, fresh buying by speculators or long term investors is not ruled out. That's why, only fresh retail buying has been witnessed as people looked at the current decline as a substantial price gain, a trend which may not sustain for long. The prices may recover gradually and in long run as the sharp fall may be considered as a temporary phenomenon.

We may now witness the erstwhile gold investors migrating to new investment avenues, say real estate or stocks and new consumers buying gold and jewellery. Cashing on, jewellery sales would pick up and discounts on making charges may go away. The trend so far since the price crash indicate that consumers and jewellery lovers have developed a fascination for gold jewellery and all showrooms across the country have thronged the jewellery shops. The new trend is that this time people are buying new gold rather than indulging in recycling / exchanging old gold jewellery.

On the other hand, recent fall in gold prices may hit the small and retail merchants as they may suffer losses in short term if the gold prices do not recover as they may not be able to hold on to inventory and will, therefore be forced to sell at prevailing prices. The jewellers in organized sector who have proper inventory and treasury management will not be hit by sudden or short volatility in bullion prices. Those who operate on gold leasing arrangements would not have suffered any major hit. The gold taken under a lease scheme provides a hedging mechanism against gold rate. In lease system, since the gold price is determined on a daily basis as gold is used, jewellers do not face the risk of buying huge quantities of gold at a fixed price and the price varies when the gold is used till the time gold is sold. Thus, gold is paid for on the basis of price it holds on each day as it is used. Further, holding nil or low gold inventory also protects the jewellers from declining customer demand. More the gold is leased without holding actual inventory, higher is bound to be the return on capital.

Jewellers / banks who sell gold coins generally sale on consignment basis and the purchase price is decided on the day of sale to customers. Most of the banks in India sell gold on commission basis. As such, they will not be impacted.

The gold crash has certainly affected the gold loan companies as their portfolio has become highly vulnerable in view of collateral value of their portfolio going down. Generally gold loans have a higher loans to value (LTV) which means a relatively higher loan disbursal against value of collateral security (gold). Thus, if there is a major fall in prices, lender becomes unsafe as there is no cushion left for security correction. It may be workable in short term but for long tenure loans, such portfolio would become highly vulnerable if prices do not improve. Pure gold loan companies, not having exposure to other portfolios, may have to revisit their business model in view of recent price crash. Banks have already started reviewing their gold loan schemes and portfolio. Any further fall in gold prices would adversely impact such companies. The only thing which could save them is frequent review of loans, short tenure of loans and additional margins.

What next ! it is nobody's prediction. The prices may not fall sharply but gold may continue to rule in the range of Rs. 24000 – 30000 band. Cyclical / occasional demands, more so in India may impact the gold prices, coupled with international developments, weakening of dollar and sovereign buying or buying by stockists etc.

 In the ultimate conclusion, it can be said that though the overall trend appears to be bearish or cautious, the gold story is still alive and will remain so. The instance like current sharp decline has never happened in past four decades (in my memory atleast). It may be advisable to stay invested in gold with cautious approach and not to follow any mad rush for it. One should believe that gold is not something to earn quick bucks. It is a portfolio hedge tool. It may also be an investment. It does well when others don't. However keep your expectations on return moderate and look for intrinsic value without fearing for corrective phases. It you are looking for more safety, go for bank deposits. Enjoy gold, buy jewellery. It you wish to invest, invest in gold ETFs. (exchange traded funds).