Is gold a good investment? | Value Research Jai, Gabbar and Basanti discuss the recent bumper returns from gold and how investors should approach this asset
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Is gold a good investment?

Jai, Gabbar and Basanti discuss the recent bumper returns from gold and how investors should approach this asset

The atmosphere in Ramgarh was festive, with the pandal on the main street overflowing with flowers and laddus to the accompaniment of loud music. Gabbar, as a part of the organising committee, occupied a strategic position next to the laddus and was judging a dance competition by kids, when Jai and Basanti dropped in.

Gabbar: Namaste, Jai and Basanti, please come. You must stay for some time. Where is Veeru?

Jai: He's visiting Mumbai, Gabbar. He loves to visit the Siddhi Vinayak temple this time of the year.

Gabbar: Do stay for 10-15 minutes so that I can get free and come and talk to you. Jai and Basanti, have a good time watching the children dance energetically.

Gabbar: Okay, let's go to a quieter place, Jai and Basanti.

Jai: Sure Gabbar, what's the matter?

Gabbar: See, you guys have always told me that mutual funds are sahi and all that and made me buy debt and equity funds. But you've never told me that gold is better. It's a bumper investment. My wife bought some gold coins last year and she says that gold prices are up 27 per cent in one year. She's making fun of me for earning minus returns on my equity funds and only 5-6 per cent on debt funds.

Basanti: Well, she's quite right on the returns, you know. I own gold ETFs and they're up 27 per cent in the last one year.

Jai: But Gabbar, that is exactly what gold investments are meant to do. They perform well when your other market investments don't. Do you know why gold ETFs in India have done so well in the last one year?

Basanti: Indian gold prices faithfully follow international prices. Six months ago, global gold prices traded at about $1,300 a troy ounce, but today they're at over $1,500. While that's only a 15 per cent gain, the rupee has also depreciated against the US dollar from about 69 to 72. India imports most of its gold so when the rupee falls against the dollar, it makes gold more expensive in India. So, we saw 24-carat gold prices in India shooting up from about Rs 33,000 for 10 grams in March to over Rs 40,000 in August. That's how Mrs Gabbar got her gains!

Gabbar: But why are global gold prices shooting up? It means people are afraid of something? It's a safe haven, I always read.

Jai: Exactly, Gabbar. You are indeed smart! In the last six months, the altercation between Trump chacha and Xi bhai has become worse with both trying to hurt each other's economies by hiking import duties. This is hitting other countries that depend on global trade, leading to the fear that another global recession may be coming. It's only with great effort that all the central banks have managed to keep their economies afloat after the previous recession caused by the 2008 US housing crisis.

Gabbar: Yes, yes, I have been reading about something called the inverted-yield curve in the US. While I couldn't understand much of it, one thing I understood is that it means the US may slip into a recession.

Jai: Yes, an inverted-yield curve is just a fancy way to say that interest rates for long-term loans in the US economy have fallen below the rates for short-term loans. Normally, it should be the opposite because while giving somebody a 10-year loan, you will demand a higher interest rate than on the one-year loan because the risk is higher.

Gabbar: So, the US yield curve is doing Shirshaasan, ha ha! But what I don't get is if the US economy slips into a recession, why should people buy gold?

Jai: Good question. The last time the US and other developed economies went into a recession after the sub-prime crisis, what did central banks do?

Basanti: That was the beginning of the famous QE. The central banks in the US, eurozone and Japan cut their interest rates to zero. They also flooded the market with liquidity by buying up bonds. They hoped that the cheap money and plenty of liquidity would make companies invest more, helping their economies climb out of the recession.

Jai: Exactly. Well, 10 years after QE was rolled out, the developed economies are still shaky. With trade wars, the fear is that they will all slip back into a recession. When a recession looms, governments and central banks usually tackle it in only two ways - cutting interest rates or printing more money to pump it into markets. But that's exactly what they have been doing for the last 10 years, leading to strange things like negative interest rates. So, everyone's scratching their head about what to do if another recession now visits the world.

Gabbar: Yes, I really like this negative interest-rate concept. I have many loans and it would be nice if the bank pays me to borrow for a new car.

Basanti: Fat chance of that happening in India.

Jai: It's not a joking matter, Gabbar. Ordinary people like you have not benefited from zero or negative interest rates; it has been very bad for savers. It is mainly banks, large funds and institutional investors that have used the cheap money to borrow and make speculative investments all over the world.

Basanti: Yes, the real reason why global stock markets and bond markets are so nervous is that they aren't sure how this will end. What if investors who have put over $15 trillion in negative-interest bonds suddenly want their money back or they begin questioning why tech companies with no profits should trade at fancy valuations? All these are signs of a bubble.

Gabbar: Hey, both of you have gone off track. Stop giving me this lecture and tell me why gold prices have gone up!

Jai: To put it very simply Gabbar, investors around the world are now worried that bond and stock markets are in the middle of bubbles that might pop. They are also worried that if central banks, including that of the US, print even more money, money will simply lose its value. No one knows how all this will end because the world has never seen things such as negative interest rates before.

Basanti: And when you fear the unknown, that you can see and feel - like gold, which has been valuable since time immemorial.

Gabbar: Thanks for giving me a good scare. So, you are telling me now that both equity and bond markets will be finished and I should have invested in gold only.

Jai: God! Not at all, Gabbar. Everything we're discussing is theoretical and in the global context. If there's global turmoil, FPI flows into India will certainly be affected. But we are not as shaky as other emerging markets, which depend a lot on global trade or foreign flows for survival. India's economy is mainly dependent on domestic consumption. Our trade numbers are quite positive currently and falling oil and commodity prices due to recession fears can actually help Indian companies. But yes, if global markets go into a meltdown, our markets and the rupee will feel the pain.

Basanti: Do remember that India has its own troubles, with a 5 per cent GDP growth in the June 2019 quarter. Things are not so good either.

Jai: But Gabbar, don't do rash things like selling all your equity and debt funds. Gold is not a long-term wealth-creating asset like equities or even bonds. Stock prices are backed by growth in the profits and dividends of underlying companies. Bonds fetch you regular income in the form of interest. But with gold, you depend only on capital appreciation to make returns. Gold returns are decided purely by the fear factor and spells of extreme fear in the market don't last long.

Basanti: Exactly, that's why there have been very long periods when gold delivered poor returns, Gabbar. After peaking at over $800 during the oil shock of 1980, it took 25 years for global gold prices to get back to that level. Gold also hit a record of over $1,900 in 2011 but eight years later, it is still 20 per cent below that price. The fall has been less in India because of the rupee depreciation.

Jai: Indian investors believe this myth that gold prices never fall. But there have been many occasions when gold prices have tanked sharply. In October-November 2008, gold prices tanked by over 20 per cent within a month. Gold again had a 20 per cent fall in the three months from September to December 2013. The timing of these falls show that gold prices shoot up sharply when fear overtakes the market but can also crash equally when the fear abates!

Gabbar: What about buying gold coins or sovereign gold bonds?

Jai: When you want to sell gold coins, the jeweller will ask for a hefty discount for making charges, caratage etc. Sovereign gold bonds are better. They offer a 2.5 per cent interest and help you mirror market prices exactly. But you can only buy them when the RBI opens a fresh issue. You are also locked into them for minimum five years until the RBI buys them back. They are not very actively traded in the market. Gold ETFs, on the other hand, are on tap. I guess that's why Basanti has them.

Gabbar: Ha ha, thanks! At least, I can tell my missus that she did the wrong thing by buying gold coins.

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