Indians' affinity towards gold investments in a bid to assuage inflation worries has been a long standing debate. The government, in particular, has pulled out all the stops to curb gold buying. But even the increase in import duty on gold failed to take away any luster from the metal. Any further increase in the import duty might encourage smuggling of gold in the country.
In order to break this vicious cycle, the FM has proposed introducing inflation-indexed bonds (IIBs) to help reduce demand for gold as inflation hedge. With the introduction of these bonds, the FM expects that investors will get weaned off gold.
But we think the government has underestimated the lure of gold that of bonds. In light of current market scenario, consumers would like to take safe bets rather than going for new investment options. Further, as per the guidelines, the bonds are linked to the WPI (wholesale price index). It is a known fact that the consumer inflation is much higher. Therefore the investor is not really protected against inflation if the IIB is linked to WPI.
Gold on the other hand has dazzled Indian investors for decades. And investors have all the reasons to be happy about owning gold. Since the end of 1978, the yellow metal has delivered nearly 620% in terms of returns. In addition, the recent troubles in Euro zone, particularly Cyprus, also support the strength of gold versus paper currencies.
As Bill Bonner recently wrote in the Daily Reckoning "The nice thing about gold is that not only does it hold its value over centuries, it is also a valuable that you can keep out of the banking system. Like jewelry or antique autos, you can keep them at home. Bury them under your own tree. Keep them in your own safe. If the banking system freezes up or breaks down...you still have them. Pass them to your children. Give them as birthday presents. Or just lock them up and forget about them." We do not think IIBs will ever be able to match up with the lure of gold.