The gold rush

The latest four letter world on everyone’s lips appears to be “Gold”. Here are a few examples:

1. Two leading Indian mutual funds have just launched Gold Exchange Traded Funds (GETFs).

2. Over the past six weeks, two popular business magazines have featured gold as the cover story, both implying that gold prices had reached a permanently higher plateau and that it was still not too late to climb onto the bandwagon.

3. Hardly a day goes by without at least one of the business television channels featuring one gold bug or another. These cheerleaders often state that they would not sell their holdings just now but wait till the price of gold doubles from today’s levels.

4. Companies offering loans against gold are advertising like never before.

However, this spurt in interest amongst the investing community contrasts sharply with realities on the ground. An article in the latest issue of “The Economist” states that Indian consumers are keeping jewellers busy not by buying but SELLING their gold jewellery and this trend has only been increasing with the periodic price rises. In fact, the same article quotes some jewellers who say that the during the recent wedding season consumers are making do with only one set of jewellery instead of the customary three. I also read recently that recent high prices have also cooled off the Chinese consumers’ ardour for gold. Last year, indeed, was the first in which investment demand exceeded jewellery demand. Purchases of gold for jewellery dropped to 2,193 tonnes in 2008 and then to 1,758 tonnes in 2009.

So which camp is correct? I guess I would go with the consumers. Logic dictates that in the case of commodities (and yes, gold is a commodity even though the gold aficionados might consider my statement as heresy) price rises sustain only if end-user demand is robust. In late 2007 the first signs of the onset of the recession in the USA led to consumer demand for oil reducing but speculator demand caused the price to rocket to a peak of around USD 150. After the last of the “shorts” had squared off their positions, the price of oil sank like a stone. This situation was also repeated recently in the copper market where investor demand (fuelled by low interest rates and a belief in the “Restocking” theory) was not adequately followed up by actual consumer demand causing severe unwinding of positions. In gold too, for the past year or so, it is the ETF led demand which is at the forefront, and not consumer or industrial demand. Ease of entry and exit has resulted in investors treating gold just as they would treat any other financial asset. Higher prices are actually bringing in more investors, even as they simultaneously induce end-users to reduce their exposure. It appears that the “Greater Fool” theory is at work right now.

This incongruous situation cannot persist for long, especially in a commodity like gold which does not yield any income to the owner. So far, the most common reasons for the rise in price include (1) gold acting as aquasi-currency in the event of a severe devaluation of any of the key global currencies or (2) it being a good store of value in case of hyperinflation caused by the runaway increase in the indebtedness of the developed world.

However, so far neither of these two bogeys appear to be actually materialising. The longer such “Armageddon” is delayed, the greater is the likelihood of all the marginal investors / speculators losing patience. When that happens gold could fall like a house of cards.

I believe that gold should have a relatively small role to play in one’s portfolio. According it more importance than it deserves could reduce the lustre of one’s overall returns.


  1. Good one. The permanently high plateau stuff is pure trash (you probably know the same was said of stock prices just before the 1929 crash). Since the dismantling of the currency standard, Gold is just another commodity (altho as you’ve said people dont want to accept that, perhaps because of its glitter) and will fluctuate like any other commodity.

  2. Fantastic note. The permanently high pateau was first popularised by Prof. Irving Fisher and recently there was a reference to the same in 2008: “Home sales are coming down from the mountain peak, but they will level out at a high plateau – a plateau that is higher than previous peaks in the housing cycle” – David Lereah, Chief Economist, National Association of Realtors

  3. Thanks for your comments. Yes, 1929 was a period when everyone was too sanguine. Right now we may be approaching that phase w.r.t. gold.

    By the way, today I received e-mailers from three brokerage firms advocating the merits of gold ETFs.

    India’s first Gold ETF was launched in February 2007. Apparently, it took three years for brokers to wake up to the merits of this product.

  4. Hey this is quite a good article you wrote. There has been a lot of hype around gold recently caused by Gold ETF’s such as Quantum.

    One of my friends has actually gone to the extent of investing 30-40% of his portfolio in gold. I sent him your article and hopefully better sense will prevail.

  5. Thank you Hersh. I guess your friend was carried away by the hype surrounding gold.

    Investing in gold related instruments has become a consensus trade. That itself may be the cause for disappointment from a returns point of view in the months ahead, even though the basic reasoning for gold investing may continue to remain valid.

  6. Based on how the Fed is printing money out of thin air, USD is loosing value in terms of GOLD. Since all exports country does not their currency to get too strong, they are either printing money or buying USD ….but this will stop eventually ….US is the largest debtor nation in the history of the world and there is no way they can pay back without printing more $ ……which means we should see inflation everywhere …food, precious metals, raw materials ….we are already seeing that ….no doubt … speculators are coming in and playing a role in creating parabolic moves …but underline trend is weakening dollar and all the fiat currencies that is not backed by gold …..So I still think Gold is the best alternative currency to hold … I still believe in holding physical instead of all ETFs.

    Maulik Shah

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