Tuesday, 15 August 2017

Gold - All that glitters is not Gold

For ages we have heard that Gold is the best investment. Elders in our families have always advised to invest in  gold and property as they are the only real assets. Indians have an age old affair with this yellow metal,  whether as jewelry or in any other form. We love buying gold and why not after all, it has always given spectacular returns. In 1950 Gold was around Rs. 99.00 per 10 grams which appreciated to Rs. 33000 by 2013. A CAGR return of 9.82%. However, post 2013, we see a negative turn on Gold. Today it is around Rs. 28000, which means a negative return of 15% in  last 4 years.

Today we shall try to understand the various factors which determine the Gold prices in International & Domestic Market.

International Market - 

We all know that the Price of any commodity depends on its demand & supply. So what affects its demand? Gold is considered as one of the safest investments around the world. When ever there is an unrest in the market or investors have any doubts about other risk prone investment avenues,  they turn to Gold. Whenever there is any unrest or armed aggression anywhere or  when a country like North Korea goes ahead with testing of Hydrogen bombs, the  price of Gold immediately appreciates. Just like gold, there is one more investment considered as a  safe bet around the world -  The US Treasury bonds.  Big investors across the world consider the US Treasury bonds as safe investment just like gold and these two asset class are considered as competitors of each other. As the returns in the US treasury Bonds increase, the investment from Gold shifts to the Bonds, and vice versa. So what happened in 2013? If you remember in 2013 US Fed Reserve started their big programe of tapering which means tapering or reduction in the US Bond buying programe resulting in an immediate turbulence in the world currency and gold market. Prices of gold started falling as the returns on US Bonds increased, investors started shifting their money from gold to the higher yielding US Bonds. After the tapering programe, US Fed Reserve started to increase interest rates in US from 0.25% interest in 2013 to 1.25% in 2017. With higher yields in US Treasury Bonds, the demand of gold in the International market remained subdued as did its price.

The International market always affects the Domestic price, however, part from the above turbulence in the International market, there are certain additional reasons that affect the price of Gold in the Domestic Market, which are :

Currency effect - The USD-INR rate. As we all know most of India’s Gold requirement is full filled through imports. Hence the price of gold in India is determined by the Price in International market multiplied by the USD-INR exchange rate. All other factors remain unchanged,  the currency fluctuation affect the price of Gold in India. In 2013 USD-INR exchange rate was around 69 which is reduced to around 64.5 in 2017. Which means we require to pay less of rupee to import same quantity of gold in 2017 as compared to 2013. Similarly if rupee falls compared to US Dollar, we may more in rupee.  Above we have seen the 50 year graph of gold prices in India, likewise if you see the 50 year graph of USD-INR you would find in 1950 INR to USD was trading at Rs. 4.76 per USD which falls to Rs. 64.5 by 2017. This appreciation in US Dollar is also auto built in the Gold prices in India.

Tax rates in the country Another factor which affects the Gold prices in the domestic market is the tax rates viz..Custom duty, GST etc.In 2013 when Rupee was on free fall, to curb the same, Govt. imposed custom duty of  10%(currently except gold to be imported from countries under FTAs.) on gold. Post the launch of GST, 4 % GST would be applicable on Gold, which is over and above the customs duty. All these taxes are inbuilt in the domestic prices of Gold.

Given the above factors, we are of the opinion that Gold prices would remain subdued or range bound for a few more years. As the US economy improves, there is all the possibility that US Fed Reserve would increase the interest rates giving more yield to US Treasury bonds. Also with the Government’s using all efforts to curb imports with various policies like Make in India, Defence production in India,  Gold monetization etc. the Current A/c deficit of the country has reduced and we may be on the verge of current A/c surplus in future. These all factors would ensure gold prices remain subdued or range bound for next few years. Large-cap stocks and equity mutual funds were the clear winners in the five-year period between 2012 and 2016—almost double in value. Returns on gold slipped to negligible. 

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