SEBI registered Investment advisor (RIA) with Registration number – INA 000000342.
Gold is nearing a bubble phase

Will you invest in Gold now expecting another 30% return like in 2011?

The glitter of the yellow metal could probably continue to attract investors this year too, especially those who are afraid of the choppy equity markets. In 2011, gold provided a splendid return of around 31%.

In fact, the fabulous return is because of the depreciating rupee against the dollar. In dollar terms, the gold return is only 10.52% in 2011. The inflated returns of Indian investors were due to the falling rupee. This is why experts are warning investors not to go overboard with gold. Many believe that the prices gold is poised for a significant correction.

History of gold price movement in dollar terms

In January 1980, Gold hit record high at $ 850 per ounce. High inflation due to strong oil prices, Soviet intervention in Afghanistan and the impact of the Iranian revolution, etc prompted investors to move into gold. After reaching those dizzy heights it then plummeted down and remained steady in the 300-400 dollar range for some years before starting to climb again to new levels. In January, 2008, gold breaks above $850 for the first time since 1980. After 28 years!

Please see the chart below showing the gold price per ounce in US Dollars

Gold Prices in Indian rupees

Gold price movement in Indian rupees will show a different picture for the period mentioned above. The price of 10gm gold in 1980 was Rs. 1330/-. This was gradually increasing without much price correction. The price crossed Rs. 12,500/- in 2008. The growth is almost 8.3% CAGR.  The price then crossed 26400 in 2011.

Please see the graph showing gold price per 10 gram in Indian rupees.

The reason for this increase in gold price in Indian rupee is the depreciation of Indian rupee against Dollar. In 1980, we can buy 1 dollar, by paying little less than eight rupees! Now, we have to pay around 52/- to buy one Dollar! In 2011, the gold prices appreciated by only 11% in dollar terms, but in Indian rupee terms it comes to 32% because the rupee depreciated around 19% against the Dollar in 2011.

With caution over European economic status, investors will prefer holding dollar. Investors are increasingly losing faith in the future prospects of the Euro. The yellow metal has witnessed a change in course. As investors are moving away from gold, the prices have already fallen from the record high of $ 1,900 per ounce on 5 September 2011.The magnitude of the decrease indicates that gold is already on the brink of a bear phase. Gold prices may see a consolidation or correction in the first half of 2012. A strengthening Dollar will affect gold prices.

Reduction in real demand

The demand for physical gold is cooling off as per the World Gold Council (WGC), data. India, which is the world’s largest market for gold jewellery and gold bars and coins, is also witnessing decline in demand.  Experts are attributing the dampening consumer enthusiasm to heightened volatility in gold price. Real demand is reducing because of the high price of the metal.

 

Investment Driven demand

Gold prices are in a bubble. The asset class is dangerously inflated due to speculative positioning. The WGC report shows that while the overall demand for gold is increasing, it is primarily fuelled by the investment demand. The demand for gold exchange traded funds and similar products are rising steadily.
In fact, it seems that globally, the investment and speculative demand is beginning to wobble as gold is increasingly being seen as overbought. Many experts are developing a firm view that the rally in the metal will consolidate, if not correct.
A recent report by Bloomberg stated that many hedge fund managers have sold gold in 2011.

Will Gold correct from this level?

Remember 1980 crash! Experts have their own grades of pessimism. Many are expecting a 15 – 20% fall in 2012. But some expects a bigger fall and then slow recovery by the end of the year. Lot of this depends on how the Euro zone issue and other major global issues are unfolding in 2012.

What should be your strategy?

If you analyse the returns from gold investment in Dollar terms for the past 30 years, it has given a CAGR of little less than 5%. In Indian rupee, the return comes to around 10% because of the huge depreciation in the Indian Rupee. This is even after taking into account the phenomenal growth in the last 3 years.

During the same 30 year period, the Sensex return in India is around 15% CAGR. This is even after taking into account the ongoing bearish phase and the steep correction in 2011. Now you decide where to invest.

Another important thing is that the equity market in India was never been in continuous bearish mode for more than 3 years in this 30 year history. But, international gold prices were not showing any significant return for very long periods like 1980 – 2008. Chances of Rupee depreciating heavily in future to get good returns from gold are remote as in the past. This clearly makes equity as a better long term investment over gold.

Gold can have around 10-15% of your investment portfolio. Increasing allocation more than this will not help you in the long term wealth creation. Don’t get carried away by seeing the huge returns in the past 3 years. It is mainly due to the global financial crisis and the rupee depreciation. The Data for the past few months shows that investors are allocating larger amounts to gold. This is not an ideal move as it is not the time to enter gold in a big way.

New investors can start systematic investment in Gold in small quantities.

4 Comments

  • Sandeep Nangrani Posted January 29, 2012 6:50 pm

    Gold coins may be bought from the Post office or any reputed jewellers from your city.

  • Vishal Posted April 8, 2012 8:30 pm

    Interested in your services. Can you please suggest more details as to how you deal with people from outside India.
    I have a corpus of over Rs 20L which I wish to invest for my long term capital appreciation need. I am not sure whether to put in Real estate or in Equity. Any thoughts please.
    Min waiting period is over 10 years.

  • Abhijit Mohan, Dubai Posted April 25, 2014 4:14 pm

    Dear Sir, I have read your article 2 years back and was bit skeptical about your views on gold. I even increased my investments in gold as per the tips of a friend. Now I realized the mistake of doing it. I want to have a through study of my portfolio and need your services for long term. Please give your contact number or email address to contact. I am based out of Dubai and is visiting India in May.

    • Melvin Joseph Posted April 25, 2014 4:16 pm

      Hi
      My contact number is 9820843739 and email Id is melvin@finvin.in

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