Why gold doesn’t glitter as well in India

Gold’s been going from peak to peak, to use a favoured phrase of mountaineers.
Spot prices of the precious metal closed at an all-time high of $1,108.91 per ounce (one ounce = 31.1 gram) on Monday, signalling firm investor interest, though on Tuesday, prices came off an intra-day high of $1,111.20 to close lower, at $1,101.12.
Since the beginning of this year, the yellow metal has given a return of 26.6% in dollar terms.

Somewhat sadly for investors in India, the world’s biggest consumer of the yellow metal, however, the returns on gold have been much lower in rupee terms, at around 21.1%.
What gives?

Blame it on the fact that the dollar has weakened against the rupee and other global currencies since the beginning of the year, say experts.

At the beginning of the year, gold was at $869.75 per ounce. At that point, one dollar was worth Rs 48.60. This meant an ounce of gold was going at Rs 42,270.
Today, one dollar is worth around Rs 46.49. So, in rupee terms, one ounce of gold works out to Rs 51,191.

This means a gain of Rs 8,921 (Rs 51,191 - Rs 42,270) per ounce or 21.1% since the beginning of the year, way below the 26.6% gain in dollar terms.

“Things priced in dollars in global terms will go up, though not necessarily in rupees because the rupee will probably go up in terms of dollars,” said Bill Bonner, the president of Agora Publishing and the principal author of a daily financial column The Daily Reckoning.

Dollar and gold share an inverse relationship. As long as the world views the dollar as a stable currency, as it has for all these years, the price of gold doesn’t go anywhere. But that has not been the case lately.

The US government owes the world much more than it can ever hope to repay. Depending on which estimate you believe, the liabilities of the US government vary from $50 trillion to $70 trillion.

“Keep in mind that the US is now carrying over $57 trillion in total public and private debt. Each 1% rise in interest rates drains $500 billion per year out of that economy —- just in added interest payments on debt,” says Jeff Nielson, editor of www.bullionbullscanada.com.

This doesn’t augur well for the US dollar. At the same time, the US has been printing dollars big time to tide over the current financial crisis. As the US prints more dollars, the supply of dollars in the market will increase. Experts feel this will, over a period of time, lead to the price of gold increasing, as investors and nations move away from the dollar and into gold. This will also lead to the value of dollar against other currencies going down further.

“Gold is rising since the dollar has been falling and is expected to continue to lose value. The dollar is losing value means the rupee is gaining. Extrapolating this logic, as gold increases in value, the rupee strengthens, too. And since internationally, the price of gold is measured in dollars and not rupees, the rupee appreciation against the dollar translates into a lower return for domestic gold owners,” says Sandeep Shanbhag, director, Wonderland Consultants, a tax and financial planning firm.

“However, this circular reference issue should not deter investors,” Shanbhag adds. “At all times, and especially in the current environment, gold should form a part of any investor’s portfolio.”

Gold price will continue to go up as long as big international investors try and get away from the dollar. “The dollar will continue to have a very big impact on the metals and gold,” says Afshin Nabavi, a senior vice-president at bullion refiner MKS Finance SA in Geneva.

Even at its current historically high price levels, gold has analysts bullish. “Gold’s rate of exchange to the dollar will soar,” says James Turk, a gold bull and co-author of The Coming Collapse of the US Dollar. “Gold has been rising all decade, but its rate of appreciation is about to accelerate as people flee fiat currencies.”

Turk’s price expectation: $1200-1,400 an ounce by the year-end and over $2,000 an ounce by end-2010.

All the same, how much money investors in India make on gold will depend on how much the rupee appreciates against the dollar.

It is possible to make out four possible scenarios for Indian investors to record any gain at all:
a) The price of gold in dollar terms goes up and the rupee depreciates against the dollar — this is the best case scenario, but highly unlikely;
b) The price of gold in dollar terms goes up and the rupee continues to quote at the same rate to the dollar as it is now;
c) The price of gold in dollar terms goes up and the rupee appreciates against the dollar, but it doesn’t appreciate as much to knock off the gain in dollar terms; and
d) The price of gold in dollar terms falls and the rupee depreciates against the dollar, so as to knock off the fall in price in dollar terms.

Whoever said investing was simple?