In the traders' forums I track, there have been hot debates for a while about the pros and cons of buying gold. Precious metals (silver, platinum and gold) are among the few assets that have appreciated over the past year.
Gold is the easiest to buy and hold due to the easy availability of exchange traded funds (ETFs) as well as the physical and futures routes. The other metals are more difficult to buy and hold. While silver and platinum futures are available, taking delivery in either is cumbersome and there are no ETFs.
In technical terms, gold especially seems on the verge of further breakouts while all three are in uptrend. Prices may move north for quite a long time and quite a distance. In trading terms, this is a "buy high, sell higher" situation. That requires a different strategy from a "buy low, hold forever" or "buy low, sell high" scenario.
Fathoming gold's behaviour
The trick to understanding gold is to treat it as another currency. It has almost zero intrinsic value except as a non-reactive, ductile, conductive metal used in obscure scientific experiments. Paper is actually more useful. The value of a currency depends on the trust people place in its buying power. If there are doubts about the soundness of the economy issuing the currency, trust is eroded. If there is a lot of currency chasing limited supplies of goods and services, buying power is also eroded.
People turn to gold when other currencies are considered less trustworthy, or there is too much "paper" in circulation (less than 10 per cent of currency is actually paper). Fiat currencies are issued at the whim of central bankers and can easily be devalued by printing more. This is one advantage gold possesses over paper: supply is limited. Gold cannot be issued ad-infinitum. It has to be dug out of the ground. So it cannot be devalued by deliberate over-supply. Right now, economies producing over 50 per cent of global GDP are busted. Japan is in crisis, so are Europe and America. Economic growth is slow or in recession and government debts are high. So, the Yen, the Euro and USD are not very trustworthy.
Across other regions, many nations are dependent on exports into US, Europe and Japan. Prime examples of exporters include China, Korea, Indonesia, and other Asian Tigers. India isn't as export oriented but specific sectors like IT, pharma, gems and jewellery, and textiles are export-driven.
All export-driven economies and sectors have capacities surplus to domestic demand. Every export-driven economy and sector will see low demand while Europe, US and Japan remain busted. So, most nations will see slowdowns. Therefore, fiat currencies in general are not so appetising.
If no fiat currency is attractive, precious metals must be more attractive by comparison. The prices of precious metals will rise while the recession lasts and the trend will reverse only as the global economy recovers.
Is gold in bubble territory?
When lots of money chases assets that are in limited supply, bubbles often develop. We have already seen some signs of this happening in precious metals. Gold is at all-time highs and the volume of trading activity is growing. That is one classic signal.
Other specific signals include the ratio of gold:silver prices and the price of gold with respect to platinum. Usually, platinum tends to be quite a bit more expensive because platinum is very useful industrially and likely to get more so, given applications such as being a catalyst in the biotech and green energy industries. (This is also true for vanadium, a less-focussed-upon metal). Right now, gold is priced at the same levels as platinum and that implies platinum may have an upside relative to gold.
The gold:silver ratio usually varies between the range 40-60. That is, gold is anywhere between 40-60 times as expensive as silver. Right now, this ratio is at 43-45, which is the lower end of the zone. That suggests gold could move up further relative to silver, which is also in a technical uptrend.
Like platinum, silver has industrial uses, especially in electronics. Demand on the manufacturing front is weak at the moment for both platinum and silver. Both are being bid up purely because they are proxy currencies. So it appears that most precious metals are promising assets that you can chase for fast returns while the global crisis lasts. However, if you are blindly converting other assets into precious metals, especially gold, consider your long-term strategy.
Must book profits
Bubbles eventually burst and then prices could slide a long way. Gold is a volatile asset. It has a history of deep declines and long periods (entire decades) of low prices. As and when the global economy recovers, gold prices will crash.
The going prices are not cheap though prices could double or triple from here in a full-blown bubble. Gold prices will also eventually fall to 70-80 per cent below the current levels if the historic pattern is maintained. So if you get in now, in order to profit from the bubble, you will have to sell at some stage. If you get in at even higher prices, the need to book profits will be even higher.
Price not right for buy and hold
Most Indians buy gold to hold as a long-term passive asset they will hand onto their children. This is not the optimum strategy at current prices in the current situation. Any gold you buy at prevailing rates must be acquired with a trader's mentality and a determination to sell. Be prepared to exit gold whenever there's a strong recovery and the equity component of your portfolio appreciates.
The equation may be somewhat different with respect to silver, platinum and perhaps, vanadium. As proxy currencies, they will go north along with gold. But these metals also have an industrial profile that will become more important as there's an economic recovery. Even as the proxy currency effect fades, the industrial demand for platinum and silver will increase. That balancing effect would perhaps offer a softer landing and a longer window of opportunity to sell and book profits in the other precious metals.