Should you invest in Gold ?

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With gold prices touching new highs, you must be regretting for not buying gold when it was “cheaper” 2-3 years ago. You must be thinking – “Should I buy gold now before any further increase in prices?”

Government has hiked the import duty in gold from 4% to 6% to curb import of gold. (ET 21-Jan-2013).  Why government wants to restrict import of gold?

In this post, I have tried to discuss these questions and various other aspects related to gold investment.

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We, Indians, love Gold and made India – the world’s largest consumer and importer of gold.  About 40 per cent of the world’s annual gold production is consumed by India and China.

In 2011 & 2012, India imported approx. 1000 tonnes ($58 billion) & 800 tonnes of gold.

A.  Where all this Gold is used?

Gold is mainly used for

  • Jewellery
  • Industrial Usage and
  • Investment (in physical bars, coins, ETF etc)

Over the last decade, there has been significant change in consumption pattern of gold.

While in 2001, 80% of the gold demand was for jewellery & 10% for investment. But in 2011, the investment demand for gold has increased to 41% and jewellery consumption was reduced to just 48% of overall gold demand.

B.  Why there is growth in Investment Demand?

Since the financial crisis in 2007, the demand for Gold as an Investment has risen many fold.

a)  Economic Crisis

Most of the bigger economies around the world are under severe pressure to revive their economies and to pay off the loads of debt they have accumulated. This has led to last resort of printing more money, which makes currencies less valuable. Equity markets were also crashed. So investors are trying to protect their wealth and investing in gold as a safe investment.

b) Fear & Safe Heaven

Apparently the fear is dominating in the market & investors are not investing in assets which have even slightest risk. They are looking for a safe heaven to invest.

c) Demand from Central Banks

For many years, central banks around the world have been net sellers (400-500 tonnes per year) of gold. But for the first time in 2010 in the past 21 years, central banks have been net buyers of gold. This trend is expected to continue.

Over the years, the central banks have had a major portion of their reserves in US dollar, with a minor portion in other currencies. However, now the central banks are accumulating gold over dollar.

d) Emerging Countries buying more gold

China has the world’s seventh largest gold reserve (1160 tonnes) which forms just 1.8% of their total foreign exchange reserves ($3 trillion). But their dependence on the dollar is gradually coming down and they are diversifying by selling dollar and buying gold.

If China were to bring this percentage in line with the global average of 11%, it would have to buy another 6000 tonnes of gold, which is more than 2 years of global gold mine production.

Japan’s gold reserves stand at a miniscule 3.2% of its total foreign exchange reserves of $1.14 trillion.

India’s gold reserves at 8.2% are much closer to the world average of 11%.

C.  Who are the major suppliers of Gold?

Supply of Gold is expected to remain restricted.  

Over the past 20 years, the supply of gold has been growing at the rate of just 0.7%. The main reason for this has been the decline of South Africa as a major producer, which produced about 1,000 tonnes in 1970, but below 200 tonnes in 2011.

Also, central banks, which were major suppliers of gold, have now turned buyers.

D. Demand & Supply Comparison

E. Impact of rising gold demand on Indian Economy

With 800 tonnes of gold import, India is the largest importer of gold. This import of gold is becoming headache for Indian government as it is impacting country’s current account deficit. Current account deficit means, our total imports are higher than our exports. See the chart below to check the impact of gold import on current account balance.

 

In 2012, the government has increased the basic customs duty on standard gold bars to 4 per cent, and on non-standard gold to 10 per cent.  In this year (2013), government is planning to hike the duty on gold to 6% to curb imports.

F.  Returns on Gold Investment

When comparing return on gold, you need to keep in mind, returns in dollar terms & rupee terms

From the chart above, the returns were pretty flat during 1982-2002  and since 2002, it has a run-up.

Gold Returns in Last 12 years in INR (2000-2012)

Do you know, that over 1980-2000 (20 years) Gold returns were just 5% CAGR (absolute returns of 177%) in INR Terms.

However, during last 5 years (2007-2012), the absolute return for Gold was 177% (CAGR – 22.5%) in INR terms.

In 2011, 2012, the returns in INR is more  because the Rupee was depreciating against USD.

In INR terms, gold prices has doubled over last 4 years and increased 4 times over last 10 years.

5 year CAGR

22.54%

10 year CAGR

18.49%

15 Year CAGR

14.85%

 CAGR – Compounded Annual Growth rate

G. Impact of Foreign exchange rate on Gold returns

As gold is imported in India, its price is impacted by the exchange rates.  Let us try and understand this through an example.

Gold currently quotes at around $1,700 per ounce. One dollar is worth Rs 55. This means one ounce of gold is priced at Rs 93,500 (one troy ounce equals 31.1grams). (Rs 3000 / gm)

If one dollar was worth Rs 50, then gold would have been at Rs 85000 per ounce. (Rs 2733 / gm)

If one dollar was worth Rs 60, gold would have been at Rs 1,20,000 per ounce. (Rs 3858 / gm)

Hence the more the rupee depreciates against the dollar, the greater will be the return on gold in rupee terms. And when the rupee appreciates, the return on gold in rupee terms will be lesser.

With interest rates declining in India, economic reforms etc, the rupee is expected to appreciate and will have negative impact the gold returns.

H. Where are Gold Prices headed?

Gold prices generally rise when sentiments on the economy and the financial markets are bearish or there is uncertainty over future trends.

Gold has been supported by a sharp increase in demand, mainly for investment, and the global economic situation, especially the debt crisis in Europe. The latter has led to an increase in demand for gold as a portfolio diversifier.

In addition, the US Federal Reserve has hinted it will keep rates low for an extended period, which will lead to higher inflation. This is another positive as gold is considered a hedge against inflation.

If China & Japan were to bring their gold reserve percentage in line with the global average of 11% of total forex reserves, the demand will increase further.

It seems that there is a strong demand for gold in near future and supply is limited, the prices will head in north.

However, if the European or US economy recovers, the investors could move towards riskier investments, resulting in a crash in gold prices.

I.  Will Gold rally in India?

Does that mean gold will rally in India? While the gold is set to rally in dollars, for Indians to make money it has to rally in rupee terms. For that to happen the Indian rupee either has to remain at the current levels against the dollar or depreciate further.

With economic reforms, FDI approvals, interest rates declining etc, the rupee is expected to appreciate. This will have negative impact the gold returns in INR terms.

J.  Should I invest in Gold?

Global broking firms have forecast gold to give 10-15% returns in dollar terms in 2013. As rupee is expected to appreciate this year, the gold returns in rupee terms could be lesser.

It is not advisable to buy gold for speculative purpose. Currently, many investors are investing in gold as it’s considered a safe investment but if the European or US economy recovers, these investors could move towards riskier investments, resulting in a crash in gold prices.

However, for investment purpose, one should go for a long-term approach in the form of a systemic investment plan (SIP) through gold ETFs.

Investment in gold is considered as hedge against inflation.  Keep the exposure to 10% of the overall investment portfolio.

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In my next article, I will write about 10 different ways to invest in Gold. Subscribe to our newletter or visit blog to read the post.

Feel free to post your comments, views etc in the comments box below.

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