The Glitter Fades, as Foretold | Value Research Gold’s precipitous decline was fully expected, and hopefully, should cure gold fever for quite some time to come...
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The Glitter Fades, as Foretold

Gold’s precipitous decline was fully expected, and hopefully, should cure gold fever for quite some time to come...

You must have heard the fable about the elephant and the blind men? Each one has a different idea of what the elephant is like, based on which part he has touched. Nowadays, gold is a little bit like that. There's the investor, who was riding a bull and has now had to get off in a hurry. There's the economic theorist, who talks about global monetary expansion and intrinsic value and things like that and is completely convinced that this is a temporary blip. Then there's the neighbour who's buying gold for family weddings and is hugely relieved at the substantially smaller bill. Oh, and there's the Government of India, which can now relax about the current account deficit.

However, the most hapless is the gold 'investor', a breed that had sprung up over the last three years after gold started its tearaway run. This lot has either lost money or made very little. Of course no comprehensive numbers can be found on how much money people made or didn't make during the gold bull run because we don't know when and how much they invested. However, I did a little calculation using the inflows and outflows from Gold Exchange Traded Funds (ETFs) as a proxy for the actions of such investors. Gold ETFs have had just about Rs 8,000 crore of inflows in all but one can assume that the timing and pattern of inflows may not be very different from that of all gold investing. The internal rate of return for these investments, since the first gold ETFs was launched, was 12 per cent per annum before the recent collapse in the price of gold. After the fall, it's just about 8.5 per cent. During this period, the price of gold itself has gone up by 270 per cent. Why the discrepancy? Why is the rate of return realised by actual investors so much lower than that of the underlying asset. The answer isn't unexpected--it's because a bulk of the trend-chasers spotted the trend too late and then became convinced of them even later. By the time they moved actual money in, they were left with that part of the bull run which has now vaporised. If you were investing in gold because it had the momentum, then you should now be gone because of the same reason.

Now, when gold prices have collapsed, all kinds of stories are being told about why it will rise again or at least why it can't fall further. One of the strangest is that gold can't fall below a certain level that is the cost of production of gold. This is a bizarre claim. Gold is not a commodity which is produced and then consumed. The amount of gold that is mined every year is about 1.5 per cent of the total global stock and actual consumption (for industrial uses) is a tenth of even that. The amount of gold that is produced plays an insignificant role in the economic activity around it. If the production of gold determined its price, then it would have been available on a cost-plus basis.

However, the collapse of gold prices can hardly be seen as an unanticipated disaster. Right from the beginning, the unsuitability of gold as an investment avenue was emphasised by many investment analysts, including me in these pages. Gold is an intrinsically useless asset because it does not produce anything or satisfy any tangible need. It's price rose so much because people though that the price would keep on rising. Now that circular logic has been broken. It will have its day again but the hopefully the events of the past few weeks will be remembered. In India, there might be some socio-cultural reasons to buy a little bit of gold, but nothing that makes it a meaningful investment.




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