Going for Gold - The Honest Truth By Ajit Dayal
Investing in India - Honest Truth by Ajit Dayal
Going for Gold A  A  A
12 AUGUST 2008

"Bindra ends 108 year wait" proclaimed the DNA headline.
And indeed it was a day to celebrate.

But there was another not-so-golden bit of news.
The price of gold, which began the year at USD 834 per troy ounce, peaked at USD 1032.7 on March 17, 2008, and slipped to USD 818.63 on August 11, 2008, the low for the year. Year-to-date, gold has declined (-)2%.

So, while Abhinav Bindra rightly celebrates his gold necklace, most investors are mourning that the gold in their portfolios feels more like a leaden albatross around their neck.

Cheer for gold
Actually, in a very strange way, the price of gold declining is a good sign!
When the price of gold increases, it means that the financial world is in trouble.
When there is trouble in financial markets, it generally reflects some problems in the real economy, in the underlying businesses that make up GDP.

That is not good for investors because most of us have our investments in mutual funds or shares. Some of us have investments in property - in a second home which earns a rental yield. In "bad" economic times, the value of our holdings in shares, mutual funds, and property tends to decline.
Sometimes sharply.
Witness the (-)40% decline in the BSE-30 Index from its January peak to its lows in July. And witness the decline in property prices in most parts of the country and a collapse in the volume of transactions in all parts of the country.

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Evolving views on gold
Initially, the reason and rationale for buying gold was purely based on the price of samosas, oil, and property prices (Please read - Of Samosas and Gold). The central banks of the world, I argued, were printing so much money that they had created what is called asset-price inflation. All that money printed is more than the new availability of goods and products so the price of the existing goods and services were increasing. Samosas, oil, and property prices had reacted to that "increase in money supply" as the economist call it. Gold, by this measure, should be over USD 3,000 per ounce.

There is another reason - sort of linked to the first. When governments print all this money and debt levels of countries head northwards, people lose faith in that currency. They can buy many samosas and barrels of oil right now today to be consumed in the future.

But since storing samosas and oil for a long time is not really easy (try and freeze the samosas and see what a daily 6 hour power cut does to the edibility of the samosa!), people would turn to a historical store of value - gold.

Gold has been the currency of the world (as has silver to a smaller extent) till the financial wizards created the "fiat" currency which was backed by gold. And then the financial shenanigans began and the currencies were no longer backed by gold but by a fraudulent "In God we trust" printed on every note. Politicians, god men, and financiers have one thing in common. They all have used the "God" word to fool everyone.

People, I surmised, may start heeding the words of The Who "we won’t get fooled again" and start buying gold. In paper they would lose their trust. In God and gold they would keep their faith.

Not out of the woods
The world has seen some pretty scary jolts in the past one year. The Bear Stearns funds announced their meltdown about one year ago and that brought to the surface a lot of crap that was shovelled under the mortgage markets and global investments in real estate linked paper. Banks are likely to see losses of USD 1 trillion (about the size of what all of India produces in one year). So far the banks have declared losses of USD 500 billion. We are at the halfway mark of a long tunnel.

Stock markets like to look ahead. Like an irritant child in the back seat they keep on asking "Are we there yet?"
Like parents-on-the-edge, we keep on saying "Soon, please wait patiently" and then - on the edge of a temper flare-up we lie: "We are nearly there". The child shouts "Yippee".
So the central bankers tell us we are nearly there.
And the stock markets shout "Yippee".

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And gold gets thrown out.
Just like that child’s toy game which kept him busy while he was in the car.
Now that the playground is not too far away, the child throws out the toy.

Uh, oh.
Parents sometimes speak the half-truths.
Central bankers don’t really say much but when they do, it may not be the whole truth.
If they did, they would frighten you.
"No, my son, we have another two days of driving to get to the playground. Hold your urge to get to the bathroom."
No, dear investor, the world is not calm, and it is not safe to head out into the open sea to swim. They have not taken care of all the monsters and sharks that lurk out there. There are many people in the world who have lived beyond their means. They have borrowed; they are leveraged up to their necks. They will default. The banks have only felt one pain so far - the mortgage mess from declining real estate prices. The credit card mess is yet to hit them. The personal loan stuff is yet to show its ugly head.

Rising dollar
Gold is down because the US Dollar is strong.
The dollar is rising because its alternatives are:

  1. The Euro - a currency zone that is so confused about which direction to head in, that it can never be an alternative to the Dollar.
  2. The Japanese Yen - a currency of a country that has done nothing for over a decade and stumbles along in past glory on past wealth
  3. The British Pound - what can you say about a country whose favourite food (Indian) is not even made in that country? Less said the better.

China and India, for all their supposed might, are of little relevance in the economic world. Would you buy an airplane made in China - if, yes, buy your life insurance with it. As for India, oh well, much as I love India and wish we would get our political act together.....let’s talk in ten years.
Nope - not going to happen.
China and India cannot provide currencies that are a medium of exchange for the world.

That leaves gold.
Hold on to that toy.
We are still in a tunnel.
That toy is your security blanket.
If you can buy more, do so.

If we are wrong, and the tunnel does show up and a "we are there" light shines on us, then everything is fine. You have reached the playground.
Your investment in shares and mutual funds will reward you very well.
The cost of buying the toy was your insurance.

Stay insured
You have life insurance (not a ULIP, I hope, because a ULIP makes more money for your agent!). You know it is good to keep life insurance.
Everyday when you get back home, you are alive.
Do you look at your life insurance and say "I am alive. This life insurance is useless"?
Do you call your agent (Now vacationing in Malaysia from your premium money) and tell him to cancel your insurance?
Because you are alive, you reason, you don’t need life insurance.
Probably not the correct way to think.

So it is with gold.
It is your insurance.
If you get back home every night and see that there is still a stock market and it is rising, be happy. Because this means that the stocks and mutual funds you own are doing well.
And gold is likely not doing too well.
But you do not need to sell your gold.
You do not need to stop your life insurance.

In fact, if the price of life insurance declines and you are not adequately covered, what would you do?
Call your agent and buy more (he must be really upset that you called him while he was on a vacation with your ULIP premium money).

So, if the price of gold declines - as it has - what should you do if you have no insurance?
Remember, we are still in a dark tunnel.
And if you do have insurance - and you are adequately covered - would you sell your insurance and/or stop paying the premiums?

Buy gold. Consider the allocation table below. And see where you stand.

Suggested allocation in Quantum Mutual Funds
Quantum Long Term Equity Fund Quantum Gold Fund
Quantum Liquid Fund
Why you should own it: An investment for the future and an opportunity to profit from the long term economic growth in India A hedge against a global financial crisis and an "insurance" for your portfolio Cash in hand for any emergency uses but should get better returns than a savings account in a bank
Suggested allocation 80% 15% 5%

Disclaimer: Past performance may or may not be sustained in the future. Mutual Fund investments are subject to market risks, fluctuation in NAV's and uncertainty of dividend distributions. Please read offer documents of the relevant schemes carefully before making any investments. Click here for the detailed risk factors and statutory information"

Note: Ajit Dayal, the author is a Director in Quantum Information Services Private Limited and Quantum Asset Management Company Private Limited. Views expressed in this article are entirely those of the author and may not be regarded as views of the Quantum Mutual Fund or Quantum Asset Management Company Private Limited or Quantum Information Services Private Limited.

Mutual Fund Investments are subject to market risks. Please read the offer documents of the respective schemes before making any investments.

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