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Gold: Hedge against panic - Views on News from Equitymaster
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  • May 6, 2002

    Gold: Hedge against panic

    In May 2001, we had written an article on Gold explaining its historical journey through the 20th century. The article also talked about why the aura of gold as an investment has dimmed over the years. At that time we had evaluated gold’s returns versus the stock markets and the dollar. Read Gold is GOLD

      BSE Sensex Rupee $ Gold (Rs)
    Mar-91 1,168.0 19.6 3,466.0
    Mar-01 3,577.0 46.8 4,260.0
    11 yr CAGR growth 11.8% 9.1% 2.1%
    Apr-02 3,385.0 48.9 5,170.0
    12 yr CAGR growth 10.2% 8.7% 3.7%

    But in recent times one again sees a spurt in gold prices. Indeed, if one had invested Rs 1,000 in the BSE Sensex in April 2001 it would probably be worth Rs 956 in April end 2002 (down 4.4%). In contrast, if one had put the same money in gold that investment would be worth Rs 1,224 (up 22% YoY). Even the dollar has only strengthened by 5% in the last one year. This means that gold has outshone most investment avenues in FY02.

    The reasons for this are not very hard to guess. Gold has always been rising in two situations. One, if there is inflation, and second when the economic outlook is grim. The spurt in gold is largely led by the second reason. In the last couple of years, the global economy has been facing a tough environment. The world’s strongest economy, the US, is still grappling with the downturn. Elsewhere, Europe too is no better off. Moreover, with the near collapse of the Japanese banking system, the confidence of the investors is shaken.

    However, difficult economic outlook is not the only factor that has contributed to this flight to gold. Increasing social unrest within countries as well as a growing number spats between nations has added to the fear of losing all. The events of September 11 heightened this fear. No wonder, the gold prices have strengthened since then.

    One has to also keep in mind that the US$ is now the currency medium of the world and as such gold as a medium of exchange between countries has lost its relevance. However, some economists feel that the debt driven US economy may falter and one may see a weakening of the dollar going forward. In case of that, gold may again return as the hedge of choice.

    All these events have seen gold prices strengthening in the last one year. History has always taught us that in a state of chaos people have always turned to gold. Argentineans holding gold at this point in time should know the real value of gold.

    So does that mean people should leave everything and start hoarding gold. Not if you want to reap the benefits of a growing economy.

    The purpose of this article and of the one before was merely to stress the fact that one should not totally ignore gold. Gold is a good hedge. It is liquid and well accepted across the globe. It is the sure means of safety in a volatile environment. But at the end, it is just a commodity. Sure it’s a precious commodity, but nevertheless a commodity, which cannot generate productive returns. It is a passive investment and not an active one. Also, European banks continue to have a sell outlook on gold despite the Washington Gold Agreement signed in September 1999.

    Central banks and international financial institutions hold more than 34,000 tonnes of gold. This is more than 13 times the annual production of the world's mines. If sold, these reserves could satisfy gold demand for more than 8 years (current demand is approximately 4,000 tonnes per year). Of this demand, 85% is typically used for jewelry.

    If one is creating one’s portfolio, it makes sense to keep some portion of it in gold, for a really rainy day. But a good portion of it should be invested in growth generating instruments like equities and bonds. But it all depends on what phase of life you are in. For more on asset allocation check out the Asset Allocator.



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