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The Big Golden Bubble

Gold, as a long-term investment, doesn't make sense for the individual investors, says Dhirendra Kumar

The crores of Indians who posses gold can be divided into three categories. There are the traditional gold holders who have family jewellery and such. Then there are financial investors who used to be few in number earlier but whose tribe has increased massively recently. And then there is Abhinav Bindra.

The Olympic gold medal was placed around Abhinav Bindra's neck on August 11 contains just about 6 grams of gold. The amount is so low because the Olympic medal is actually made of silver and is just gilded with gold to give it a gold colour. When the medal was presented to Bindra, this gold was worth about 7,200 rupees. Six days later, at the time when I'm writing these words, the gold in that medal is worth Rs 6,650, about 8 per cent less.

I'm sure Abhinav doesn't mind this drop in the value of his medal, but everyone who has any investments in gold is probably seriously worried. In just the last one month, gold is down 19 per cent. As an investment analyst, I wouldn't have bothered writing about with gold till about a couple of years back. However, this has changed now. Over this time, a few things have happened that have led to an increase in the number of people who consider gold to be a financial investment. This has come about because of the tremendous rise in the price of gold, coupled with the wide availability of new avenues for investing in gold. The MCX exchange has made short-term trading and even day-trading of gold available to practically anyone who is interested. Gold exchange-traded funds have also played a role by making gold available without having to hold it physically.

However, the real reason why so many people got so attracted to investing in gold is the huge increase in the price of gold. From early 2005, when gold first started catching the attention of a broader class of investors to March 2008, the price of gold more than doubled. Moreover, the wide availability of margin trading meant that many short-term traders made a great deal of easy money in this bull run. By late last year, investors' attitudes towards gold started showing the same irrationality as it does during any kind of bubble. People started believing that gold prices could never fall significantly. All manner of strange logic was invented to prove why gold was different and why investing in it was bound to be lucrative. In India, gold has some of the same halo around its head that real estate has. A certain traditional point of view psychologically classifies gold and land as investment but shares as speculation.

However, the long-term price of gold is subject to the same laws of supply and demand as that of any other commodity. High prices leads to less buying and that eventually depresses prices again. Any steep increase in prices is temporary as the very price increase that attracts investors leads to lower prices. Gold is worse because its real consumption (industrial uses) is negligible and much of it replaceable. Almost all the gold that has ever been mined still exists. In this sense, unlike almost every other commodity, gold is not going to run out. This isn't oil, not by a long shot.

At this point of time, gold appears to have gone through a massive bubble and is now deflating rapidly. Like any other speculative investment, it will have its ups and downs. For the individual investor, it doesn't make sense to buy gold as a long-term investor. In the long run, the ups and downs of gold are unlikely to do much more than hold to the inflation rate. At best, you could estimate the amount of gold you need for a child's wedding and target that with regular purchases of a gold ETF.