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| Edited By: Sandip Sabharwal |Source: |Updated: Mar 20, 2018, 03:49 AM IST
'The risk of investing is the highest when the perception of risk is lowest, and vice versa.'
What this essentially implies is that when the situation is benign, most people are confident about investing in a particular asset class -- the risk, in all probability, in that asset class, is the highest. I have been negative on gold for a very long time, in typical contrarian play.
Gold prices topped out in the third quarter of 2011 at $1,900 per ounce, and has since fallen 40% in dollar terms. This was incidentally the time when most central banks were buying huge amount of gold and flows into Gold ETFs were at record highs. The fall has been relatively muted in rupee terms due to the depreciation of the INR as well as the imposition of higher import duties at 2% in 2011, and 10% today. In INR terms, the fall from the peak is around 25%. The key is to understand what lies ahead.
Indians, traditionally, have been comfortable with investing in three asset classes:
As a result, because of historical factors and the view of gold as a preserver of value, as we talk, Indians have accumulated approximately 25,000 tonnes of gold valued at Rs 62,50,000 crore at current market prices. This is almost 70% of total bank deposits of Rs 90,00,000 crore. Total investor assets in equity mutual funds today stand at Rs 3,50,000 crore. Even at reduced levels of consumption, total gold imports into India stand at around 800 tonnes per annum, valued at Rs 2,00,000 crore. The key is to see if such disproportionate allocation to gold makes sense.
Historical analysis of gold from the spike witnessed in the 1980s suggests that a surge in prices like the one seen in 2011 -- when gold prices nearly tripled from 2008 levels – leads to a phase of decline and sideways move of prices for years. The spike in prices was due to various factors -- loss of faith in paper currencies (apparently), the aftermath of the global financial crisis, the Eurozone Crisis, US Fed printing more currency, which was expected to generate huge inflation.
However, in reality, most of these worst case scenarios did not play out, and today we see stabilization and recovery in most parts of the global economy.
As economic growth accelerates and inflation remains subdued globally for a prolonged period of time, we are likely to see gold prices subdued for a very long time. This does not mean that gold prices will keep on declining. My view is that they should bottom out sometime over the next few months at around 50% of the peak value. This value comes at around $950 per ounce. It is possible that there could be some undershooting by about 10% too. After that, in all probability, we could see prices in a range for several years. This does not mean that prices will not move up. Swings of upto 30-40% after bottoming are quite possible.
This is important from traders' perspective. From an investors' perspective, the probability that gold will not create any wealth for several years, is extremely high.
From the perspective of someone who stays in India, we are at the bottom of the economic cycle. As recovery gains steam, greater wealth will be created from assets that benefit from economic recovery. The increase in gold prices from $250 to $1,900 per ounce from 2001 to 2011 created a belief in the investors' minds that gold will always keep moving up. It was at this time that allocation towards real estate and gold became disproportionate. Had it not been for a 45% decline in the value of the rupee from 2011 till date, and an additional 8% customs duty, gold prices in rupee terms at this point would have been Rs 16,500 per 10 grams as against the current Rs 25,000-level per 10 grams. This would have been hugely destructive for most people in India who hold gold.
Investment demand for gold is unlikely to come back any time soon; China has also lost interest in gold. Central Bank buying that normally follows price movements has moderated significantly. It is also important to realize that current gold prices are in spite of sanctions on Russia, which is one of the most prominent producers of gold today. A lot of gold that could have been flowing into the international market is currently stuck in Russia, which could be released at some stage. As such, even the demand-supply scenario also does not look favourable for gold prices. Buying gold with the expectation to make money is unlikely to play out any time in the near future.
All that glitters is not gold.
Sandip Sabharwal is a fund manager who runs an investment advisory company. He can be reached at his website.
