Gold not a good investment for now

April 22, 2013

(Any opinions expressed here are those of the author and not of Thomson Reuters)

Since November, the price of gold has been unstable but in April, its decline was precipitated. What is surprising is not the fall itself but its speed. In just two sessions, gold prices dropped 13 percent in the steepest fall in 33 years. It wasn’t gold alone that got caught in the bear grip. Prices of other commodities such as silver, crude oil, copper and so on also declined, but not as sharply.

Why? Simply because the factors that caused commodity prices to rise in the last five years were no longer relevant. Gold was selling at $625 an ounce (860 rupees per gram) only six years back in 2008. That October, the world was plunged into a financial crisis of an unusual magnitude. Since then, there has been a rush for gold as an investment. Stock markets crashed, interest rates plunged, investors lost faith in financial assets and opted for gold as a safe investment.

That presumption was supported by subsequent trends in gold prices. Over the next five years, prices shot up in India as much as 3-1/2 times, making gold not only safe but also the most lucrative investment. The stock market took all that time to recover from the 2008 shock but has not, even now, come up to pre-crisis levels. Gold became a preferred part of the portfolio and gold-backed exchange traded funds (ETFs) were a favourite with investors.

The financial crisis had engulfed the world economy. Some countries such as the United States, Japan and the UK went into short recessions. Most emerging market economies had to slow their pace of growth. In this context, gold became a hedge against economic adversity. These conditions have now changed and caused gold prices to fall.

Dow Jones is back in the hands of the bulls, home prices in the U.S. have been rising, the Federal Reserve will reduce asset purchases which were used to pump in money, and the dollar has gained against the euro and yen. As a result, confidence in the financial markets has returned, making alternatives to investment in gold more attractive.

The trigger for the collapse of gold prices on April 13 was mainly the decision of the Cyprus government to raise money by selling gold valued at $523 million. That was supported by the European Central Bank which even encouraged other countries in Europe facing sovereign debt problems to do likewise, creating the scare that the market for gold will be flooded. The price of gold dropped in anticipation. Many investors trimmed their positions in ETFs but not retail investors.

The fall in the price of gold is a market adjustment influenced by greater confidence and better yields in other assets. Possibly, there may not be further price correction in the current year except for short periods. But a sharp increase in prices is equally unlikely. That does not make gold a good investment for the present.

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