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Will gold's shine last?

Sangita Shah | January 06, 2003

The phoenix is rising again. The centuries-old attraction for gold is intact, or even a bit stronger than before, as indicated by the latest price surge globally and even in the domestic market.

The yellow metal has witnessed a price appreciation of more than 25 per cent in calendar 2002.

Like any other commodity, gold reacts to the basic demand-supply equation, but tends to be more volatile in war-like situations.

In the last couple of years, when equities as an asset class have been faring poorly after the technology bust, and debt has not been so lucrative globally, conflict situations in various corners of the globe have helped gold re-emerge as a preferred hedge against uncertainty.

Paper currencies have clearly been losing ground to the yellow metal, a fact substantiated by the weak dollar value.

In Japan last year,  even small-time savers started investing in gold after the monetary authority decided to charge investors for parking their savings in banks instead of paying interest.

Though war fears in the Middle East and weak currencies have been partly responsible for the fresh interest in gold,  the moot question is whether this trend will continue in the foreseeable future.

While many analysts of international repute have been forecasting that gold will breach its all-time high of $414.80 per ounce in 2003, prices in India are expected to soar far beyond the all-time high of Rs 5,780 per 10 gms.

It is very interesting to understand why Indian gold prices may shoot ahead of global highs. Most Indian gold is imported, and there is nothing domestic about it except for the people's insatiable appetite for it.

In February 1996, when international gold hit its all-time high of $414.80 per ounce, the dollar-rupee exchange rate was Rs 37.03.

Since then the dollar has appreciated by more than 25 per cent, to reach the current level of about Rs 48. Over and above the dollar-rupee rate, one also has to keep tabs on the various taxes levied on gold - from customs duty to sales tax and octroi.

These factors in themselves make gold costlier in India than abroad.

In India, gold has always been fancied for use as jewellery. Though gold is hoarded for a rainy day, it is not really seen as investment asset where one can make profits.

However, things are set to change partly, and many people could well start looking at gold as an investment vehicle.

While equities and debt have always formed a major part of individual investments along with small savings and insurance instruments, gold may now find a place in the portfolio - something on which one can gain by booking profits at higher levels.

However, it needs to be noted that gold often tends to have a negative correlation to stock prices. Historically,  gold prices tend to remain steady or rise whenever the stock markets are in decline.

There have been many changes in the Indian gold trade over the last few years, with banks being allowed to import gold.

While some banks, and especially the foreign ones, have closed down their operations after showing an initial interest, the rest are still struggling to handle the high volatility in the global price of the commodity.

Considering all the negatives for an average investor, its difficult to promote the idea that gold in physical form should be considered an investible asset.

The best way out is to promote gold-based mutual funds or gold-deposit schemes.  Assuming one still has to hold gold in physical form, it is best for investors to invest in gold bars rather than jewellery because price appreciation happens only in pure gold.

And jewellery, even if originally pure, tends to lose value if it has to be melted again into pure metal.

Making costs account for a large part of jewellery value, and this element will have to be factored in.

The worst part about jewellery is that it has no standard quality. Hallmarking has not been a great help to India and very few investors bother to check such things.

It is generally the local or family goldsmith who delivers the ornaments, which can range from 14 carats to 22 carats, thus reducing the value of gold held as jewellery.

If gold held as bars is then the only investment option, a caveat is in order here too: investment at current price levels is risky.

It is worth remembering that there are never quick gains in gold trading, simply because there is no futures market in India.

An investor has to buy at lower levels and sell at higher levels. That takes time. Given market uncertainties and the problems associated with holding gold in the form of jewellery, the only real benefit of investing in the metal could be the tax advantages involved.

When gold is held as a capital asset, it gets concessional treatment in the form of cost indexation for inflation when held for more than three years.

In any case, even a solid upward trend in gold price may not mean that returns from the investment will be attractive. Notwithstanding the sharp upsurge in prices since January 2002, returns from gold have not been attractive for a buy-and-hold investor.

Overall, the outlook is uncertain and the past record is not encouraging for retail investors to consider investing in gold.

While the outlook for the next two years appears positive for the precious metal, the longer-term outlook is still not that promising.

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