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Straight from the Specialists

Is gold a good investment once again?

February 28, 2014

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

The increase in gold prices in the last two months has rekindled interest in the yellow metal as a vehicle for investment. It was after the 2008 global financial crisis that gold became the most preferred asset, with prices doubling in four years.

Why was gold preferred? It was not so much as a hedge against inflation but as an insurance against uncertainty. When the economy is faltering and the future looks bleak, gold becomes a preferred asset.

After the 2008 crisis, there was hardly any asset that could conserve the value of investment. Property prices were down, stock markets had crashed, and interest rates were down to near zero. Gold came to the rescue as an earning asset.

Gold prices in India shot up from 13,662 rupees ($221) for 10 grams at the beginning of 2009 to nearly 31,000 rupees ($502) at the beginning of 2013. Thereafter, prices started to decline. In just one year, gold prices dropped 8 percent. That appeared to be the end of the metal as a safe investment.

International gold prices also declined as the uncertainty which dogged the world economy gradually diminished. The U.S. economy improved, and unemployment figures dropped to 6.5 percent – well below the target set by the Federal Reserve.

Gold was no longer in demand as an insurance against uncertainty because business confidence had returned. There was a shift to other assets like stocks and bonds.  Disinvestment in gold, particularly in exchange-traded funds, forced prices down by 28 percent.

The year 2013 was bad for gold in India as the prices fell by 6 percent. That was still small compared to the fall in international prices, mainly because of the weakening of the rupee. Lower international prices inflated demand for gold in India, bloated the current account deficit and forced the government to raise import duty by 10 percent. Imports consequently dropped, though it made gold smuggling and import via non-resident Indians more rewarding to keep up market supply.

The risk appetite for gold in India has increased recently because there is greater economic uncertainty – stock prices have become more volatile, unemployment has increased, property prices have dropped, and GDP growth has shrunk. Gold as an insurance against uncertainty has again become attractive, pushing up prices in the last two months.

Gold has become less attractive to U.S. and European investors but more attractive to Indians and Chinese. It is only when growth picks up and industry is back on track that the market for equity will revive, and subside for gold. Until then, gold can still be a good investment in India, but possibly not after 2014.

 

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