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To buy or not to buy gold?

By Prasanna D Zore
November 11, 2008 13:05 IST
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Rakesh Ojha, a rookie investor, had made decent returns in the stock market in the last 14 months. But the crash that began this January has left him gasping for breath for such are his losses.

Rakesh is only 26 and 14 months into his first job. Two years back he had invested most of his savings into stock markets and equity-oriented mutual funds. With every 1,000-point rise in the stock market Rakesh's gains had only multiplied. Today, after losing several lakhs since this January, when the stock market crash started, he has become a little wiser.

So now he has a new question: Should he invest in gold?

"But why gold?" you may want to ask. "Why not invest in a home, stocks or mutual funds (now that the markets have come down significantly), bank fixed deposits, etc?"

The reason is there are many investors like Rakesh who have burnt their fingers in the recent stock market carnage, property markets and now want to seek safe investments. And gold, for a number of reasons offers safety, a good bet against inflation and a decent return if you look at its history.

It is during times like the current ones that investors want to protect their profits from getting eroded sharply. Let us see how gold prices have moved up historically and try to answer Rakesh's question.

Gold prices have always experienced an upward kick whenever there was a global crisis: political or financial. From the first oil crisis that shook the world in 1973, when gold prices ruled at less than $ 100 an ounce (1 ounce = 28.3495231 grams) to almost $ 750 an ounce currently, gold has delivered a return of 650 per cent in the last 35 years.

Even in the last ten years gold has given a return of 200 per cent. So has the Indian stock market. However, the only difference is stock markets are seen as volatile and risky investments in India but gold is seen as a store of value.

But will gold be a safe bet in the future as well? Those who invest in markets know this dictum very well: past performance is never a guarantee for future returns.

Rakesh Bansal of SMC, an investment solutions & services firm based out of Delhi, believes that this is not the right time to buy gold at prevailing market prices. Gold prices (per 10 grams) ended at Rs 11,785, up Rs 70 on November 10.

According to him gold can reach $ 600 an ounce in the next six months. Investors can perhaps look to buy gold at that point in time, he says. Gold, he says, was trading at $ 830 an ounce in September and thereafter it maved to a high of $ 930 an ounce. But after the US sub-prime crisis came into the open gold prices have only come down. Usually, in times of financial crisis, gold prices have always moved up.

But this time it will be different, believes Bansal. What he means is even if we are in the midst of a financial crisis currently gold prices will not go up. And he has reasons to say so.

He thinks that if gold prices stay below $ 717 an ounce it will make a new low of $ 600 an ounce in the next six months.

However, another analyst from a south based brokerage house, who requested not to be named, feels that the time is ripe for investors to buy gold.

"Investors can expect a 40 to 50 per cent returns if they buy today and remain invested for the next five years," he said. Gold prices were trading at $ 751 an ounce November 10.

He feels that gold has always proved to be a safe haven and provided easy liquidity (could be sold without any problems and converted into cash). "In the current financial meltdown when the stock markets are crashing, property prices are expected to crash, oil prices have crashed gold can offer enormous safety."

He believes that gold prices will not go below Rs 11,200 in the near future as demand at this price is very high from the Indian middle class (the biggest consumer of gold). Also, we are right into the middle of a wedding season and demand is likely to remain strong for another four months.

Nevertheless Bansal has his own reasons to believe why gold will crash in the next six months.

According to him the US dollar will soon become stronger in comparison with other currencies like the Euro, Sterling Pound, the Japanes Yen and the Korean Won. Gold price is inversely related to dollars' strength. If dollar becomes stronger gold prices dip and vice versa.

"This is not a right time to buy gold at all," he asserts.

But technically speaking wouldn't America's handling of the financial crisis weaken the dollar against other currencies. "No," argues Bansal.

By spending more than $ 1 trillion to save American banks and loan markets from collapsing the US dollar might weaken against other currencies (because supply will be high; law of economics states that an increase in supply of any commodity -- dollar in our case -- without an equivalent demand for the same decreases the value of that commodity). But the US government will do this by selling gold reserves it has in its vaults and not by printing more dollars (thereby increasing the supply).

This will help the US dollar maintain its position as the store of value like most investors think that gold is.

The US government will use everything in its armoury to create a demand for dollar and supply for gold to protect their own currency from weakening. And a stronger dollar will always mean weaker gold prices.

Reading the above arguments Rakesh may remain as confused as ever on buying gold. However, here are a few reasons why ordinary people as well as investors have always bought gold:

  • Returns from investment in gold help offset losses from other asset classes, say, stocks
  • Gold has always proved as a good hedge against inflation (gold price increase with increase in inflation)
  • Gold, as an investment, is a very liquid asset; can be bought or sold ease
  • Historically, gold has proved its mettle by giving steady returns
  • Traditionally, most Indian households see gold as a store of value

While most people buy gold jewellery to invest their money it is not always a good idea to do so. The reason being the investor is not assured of the quality and quantity of gold bought as well as spend money on making charges which are quite high at some jewellers' shops.

To overcome such problems investors can buy gold bars directly from banks. Most banks offer gold bars in 5-gram and 10-gram gold bars assuring you of the quality as well as quantity. Usually, the cost of a 10-gram gold bar retails at the prevailing market price on the day of purchase.

As on November 11 Bank of India is selling a 10-gram gold bar at Rs 12,790 inclusive of sales tax and value added tax.

Investors who are market-savvy and are not interested in buying gold in physical form can invest their money in a gold exchange traded fund. This product allows investors to buy and sell gold ETFs just like shares.

Benchmark Mutual Fund's Benchmark Gold BeEs UTI Mutual Fund's UTI Gold ETF and Kotak Gold ETF are a few mutual fund companies that are offering Gold ETFs.

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Prasanna D Zore