An Interesting Story of 'GOLD'


4 min read
An Interesting Story of 'GOLD'

Image source: Gold vector created by macrovector - www.freepik.com

Do you know how US comes out of 1929 the Great Depression?

US FED needed to print money. For printing money they needed gold and for gold they needed money. In 1933, then US President Franklin D. Roosevelt nationalized all the gold owned by Americans. He passed the law criminalizing owning of gold in the entire territory of US. It was not headline, it was last page new and anybody hardly remember. Citizens surrendered their wedding rings at below-market price so that US government can print more $. They won and they are the superpower.

Let’s come back to India, A few days back I heard the announcement that Govt is thinking to implement gold amnesty scheme for unaccounted holders i.e. People who declare their gold holdings will have to deposit some of the legalised gold with the government for a few years. As per the Gold amnesty scheme, 33% tax will have to be paid on entire value of gold declared by an individual that has been purchased without any receipt. Hope you aren’t holding any gold without bill :)

All because of what? To lower the dependence on imports.

But, why?

India imported $32.8 billion worth in 2018–19. Between March 2011 and March 2019 alone the net import of gold and precious stones amounted to about $245 billion. By slowing down gold imports, we will stop the flight of savings and capital, push retained savings for domestic investments to generate higher GDP growth. Growth can’t happen without money.

So Government increased import duty from 10% to 12.5% to discourage gold demand and import. This trick counted against the government and it has in fact created a higher demand for gold as returns have become attractive. It’s like keep on buying something you can’t afford.

People are also opting for gold for investment because, over the last several years, gold has generated returns equivalent to benchmark Sensex at the BSE.

The upward movement of gold price can be explained with three reasons. Movement due to demand and supply, Rupee depreciation, and the import duty, as the local gold price is higher than the global price by 12.5% due to import duty. Gold price with import duty will be Rs 51,250 per 10 gram and without import duty will be Rs 45,555 per 10 gram.

In some sense, there is a self-fulfilling cycle in gold as higher Indian demand for gold increases price and results in weaker rupee, which makes gold returns look better, which in turn increases demand. If we had channelized the savings in the economy, it would have resulted in higher domestic investments, higher GDP growth, higher corporate earning, and higher equity gains. It would also have arrested the slide of rupee against the dollar.

More importantly, the import duty has encouraged gold smuggling, resulting in the expansion of the black economy market. Jewellery industry begged government to reduce import duty.

As coronavirus affected the imports so badly that we’ve seen a sharp decline in the physical demand for gold. China and India, the world’s biggest buyers of gold bars, coins and jewellery are not willing to import anymore due to weaker demand. As per data, Gold demand crashes 70% in April-June as COVID-19 lockdown keep buyers away.

But wait, In this pandemic Gold has seen its biggest rally ever. Globally, gold prices have risen over 18% in 2020 — the highest since 2011. At one point, it was trading at a whopping ₹ 5,500 per gram for the first time in history. Why?

Why Gold spiked to record high levels? The better explanation is that gold makes up a fairly consistent portion of the world’s portfolio of liquid investments, and much of the recent price spike was just a reversion to the mean. Add together the market capitalization of the world’s equity markets, the value of global bonds outstanding, and the 42,619 metric tons of private investment gold comes close to $200 trillion of liquid investment assets. Over the past five years, gold has made up a remarkably stable share of this pile at around 1.09%, rarely dropping below 1% or above 1.2%.

On Aug 11, 2020, the gold price fell 5.7%, the sharpest drop in seven years. (Gold hasn’t dropped below $1,000 an ounce since 2009).

The metal has one genuinely useful property — its unrivaled ability to move in the opposite direction to equities and bond yields. That’s why when stock market goes down, gold surges and vice versa. That negative beta means that a sprinkling of gold in a typical investment portfolio can help smooth out the peaks and troughs in market cycles and achieve a better risk-adjusted return in the long run.

If you are an investor with a high-risk profile, you will search the asset class which must appreciate with time and must be a safe source too. The Safest investment on earth is the US Treasury because the United States government has never defaulted on its obligations to pay. It has never, ever missed a payment.

On March 15th, the US Federal Reserve lowered its federal funds’ target to a range extending from 0% to 0.25% due to economic reformation which was thrashed due to the pandemic. US Treasury is a barometer that gives you some idea of what banks expect to make whilst lending money to each other.

Since US government is eyeing to lower its interest rates nearly to 0 then there is very little money can be made and investors had to shift elsewhere. Something that must offer you psychological comfort at a time when geopolitical tensions are high. At a time when a virus looms large. At a time when uncertainty lurks around every corner. So, can you think of any better option?

GOLD.

And the historic gold rally is explained in 5 minutes.


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Akshay Seth
Research Analyst (SEBI Regd.)
Linkedin | akshay.equity@gmail.com

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