Is investing in gold a smart move?

The precious metal has not kept up with inflation since its great rise in 1980.

Except for the ritual purchase of gold during Diwali, retail purchase of gold coins in India originates from a fear “in case all hell breaks loose”. In times of prosperity, it also gives a sense of pride to the owner.

Gold, in recent times, has been hawked more like as an asset class for investment. If statistics are to be believed 90 per cent of retail traders actually lose money as they lose clarity on the purpose of investment over time – speculation, investment or security.

Powerful benchmark

However, on a macro scale, gold is a powerful competitive international benchmark and that, if allowed to function in a free market, will determine the value of other currencies, the level of interest rates and the value of government bonds. Gold's performance is usually the opposite to that of currencies and bonds. Hence, to defend currencies and bonds, gold prices have to be fought.

Imaginary supply

Despite gold’s tremendous price increase over the last decade, the precious metal has not kept up with inflation since its last great rise in 1980. Somehow, no one questions as to why it has not kept up with inflation. The answer is that gold derivatives have created a vast imaginary supply for which delivery has not been sought for, since most investors internationally choose to leave their purchases as deposit with the bullion banks that sell them imaginary gold.

On the other hand, in India, gold coins bought even from an established seller (e.g. banks, PSUs) cannot be sold back. So, if gold as an investment has inherent liquidity loss then what is the rational of buying?

Paper promises

All commodity futures markets have created paper promises of supply that could not be covered by real product and have always been settled in cash. RBI had estimated the ratio of paper gold to real gold at 92 to 1. (RBI Report on Issues Related to Gold Imports and Gold Loan – January 2013, Page 58).

Most commodity markets are for goods that eventually are delivered and consumed to a great extent. Gold is different. For gold is not consumed but rather hoarded, even as most gold purchased in the futures markets is never delivered at all (or in miniscule percentage). This system has produced a disproportionate amount of imaginary, elastic, but undeliverable supply, even as people buy gold precisely because they assume that its supply is not elastic, the supply is limited to total past production plus annual mine production.

Caution required

At this point, individual traders in India should be cautious. In view of the recent fall in gold prices, cautiousness rather than optimism should be the watchword.

Published in The Business Line on Nov 6, 2014

Investing in Precious Metals can be Tricky

It takes two to tango but a bunch of ill-informed commodity analysts to create hype around contango. Investors in precious metals must avoid the drove of commodities analysts – as there are few signs of intelligent-life.

Despite the tall claim that India is no longer a price taker for gold but a price setter, the claim does not cut much ice. We are all clueless of the happenings in the international market. Price and investment hype have come at a time when internationally one large market maker is sitting with the largest concentrated-position in the gold market in history (“short”), while the other large entity is sitting with the largest concentrated-position in the history of the silver market (also “short”). They are investing in commodity which has become genuinely “scarce”, due to the manipulation of the market.

The explanation of "hedging" by gold and silver mining concerns is even more amusing. Miners sell forward their future output, essentially selling naked, sometimes going out as many as several years. Then they cover part of their short position through purchases of call options. One can hedge physical gold, but can one hedge gold locked up in ore deposits!

In an Indian scenario a buy-and-hold strategy has become the profit-making proposition for many. The gold market has always been a contango market. This means that the gold spread has always reflected the carrying charge, the opportunity cost of carrying gold, most of which is foregone interest. The reason a large contango is rare is because it’s too easy to profit from it.

In the technical jargon of the futures markets, the basis is the spread between the nearest futures price and the cash price in the same location, but a strange phenomenon has manifested itself. Rather than remaining constant, the basis as a percentage of the rate of interest has been vanishing and now has dropped to zero. Has anyone checked the Indian “basis”? What about physical delivery… still a chimera or is it quality certification issue which ensures that this remains a chimera.

Growing numbers of investors are being drawn towards this market of buying precious metals. With festival and marriage season about to start….Gold, gold, gold...everyone may say...let us collect gold by which we shall remain wealthy... The banks, exchanges, analysts, brokers, mutual funds are misguiding people who seek to protect their wealth. Gold is a cleverly designed trap. This trap has caught the middle class, upper-middle class, and upper class, totally off guard. Hundreds of thousands of hard-working people will invest their savings in gold, believing that the risk is non-existent, and that their wealth is protected against severe market fluctuations and hyper-inflation.

Gold had lost nearly eight seven percent of its investment purchasing power between 1980 and 2000. That was during the best period for growing businesses in the twentieth century.  It is often said “Buy facts and sell fiction” but how does one distinguish which is the fact and what is the fiction …. at a time when analysts are manipulated and there are hardly any facts apart from the rumors. And what if the entire gold futures turn towards “backwardation”? Will that be a fact or fiction…..

Published in The Economic Times 06 Sep, 2010

A run on bullion banks may have just begun

Description of gold by Keynes as “barbaric relic of human irrationality” is nowhere more evident than Indians insatiable appetite for gold. Gold demand shall continue to remain inelastic for Indians as it is bought mainly for store of value, future consumption (gift and wedding), last resort during bad days or mere speculation. Though India is the largest consumer, it shall remain a price taker of gold from London & New York.

A look at the last month’s price graph will show that the prices have been falling. However, a one and ten year’s price data gives an upward trend. The banks are evidently en-cashing on the Indian consumer behavior and earning handsome profits of 5 to 7 percent from gold coin sales. The banks do not buyback the gold coins sold (even though coins shall remain preserved in tamperproof packing along with Assayer certificate). Inspite of the quote variance by the banks, the gold coin sales remain buoyant.

A look at the last month’s price graph will show that the prices have been falling. However, a one and ten year’s price data gives an upward trend. The banks are evidently en-cashing on the Indian consumer behavior and earning handsome profits of 5 to 7 percent from gold coin sales. The banks do not buyback the gold coins sold (even though coins shall remain preserved in tamperproof packing along with Assayer certificate). Inspite of the quote variance by the banks, the gold coin sales remain buoyant.


LBMA, the London-based trade association that represents the wholesale bullion market with focus on international OTC (Over-the-Counter) market for gold, with a client base that includes majority of the central banks that hold gold, producers, refiners, fabricators and other traders throughout the world has just taken the highly unusual step of blocking access to statistics relating to the trading activities of its member bullion banks. This information has been available to the public since January 1997 but since last week it is available only to LBMA members. When the LBMA first made its trading statistics available, observers and analysts were shocked. No one could reconcile the statistics with other market data, nor comprehend how the bullion banks could be trading on a net basis of more than 240,000 tonnes of gold annually while the global mine output was only 2,400 tonnes.

At a recent public hearing of the CFTC on precious metals futures markets, some people had cited the LBMA's own statistics to label the "unallocated gold" accounts of the bullion banks as a Ponzi scheme. There were bullion bank representatives at the hearing but no one expressed an objection. In fact at that hearing, one of the world’s foremost authorities on the markets for precious metals, Jeffrey Christian CEO of the CPM Group had stated that 100 ounces of paper gold are traded for every 1 ounce of physical gold.

This June, the LBMA trading statistics showed that in May 2010 the average net daily trading in gold by LBMA member banks had moved to 24 million ounces per day from 16 million ounces per day…..A massive 50 percent jump within a month. That translates to $7.5 trillion annually. If an operation is running on a razor-thin fractional reserve basis, such step changes are often fatal.

Typically when people are exposed in a scandal their first reaction is to cover-up. It seems that the LBMA has now commenced a cover-up with respect to the gold trading activities of its member bullion banks, withdrawing statistics from the public domain. There is a cover-up of back-door injections of liquidity of physical gold, and the LBMA now is trying to conceal trading information. …..It appears that a run on the bullion banks has commenced.

Published in The Economic Times, August 2, 2010

All that glitters is not gold

Aman Dhall & Dheeraj Tiwari  (c)The Economic Times

4 Nov, 2007

The glitter of gold may not be the same this festive season with prices of the precious metal reaching an all  time high. But amidst this volatility in the international markets, the latest option of investment in gold through futures and exchange traded funds (ETFs) is wooing a new set of investors. Here’s an insight into why you should prefer investment in futures and ETFs over gold. 

Shining Instruments

So how does the mechanism of ETFs works? For starters, these funds are traded on stock exhange much the same as a regular stock does. “ETFs are essentially passively managed funds. If you buy a Gold ETF there is no real fund management involved and your invested money is simply used to buy the underlying commodity,” explains Jayant Manglik, head, commodity business, Religare Commodities, a Ranbaxy promoter group company.

Compared to buying the physical commodity, ETFs allow you to buy ‘units’. So you can invest in small amounts. There is also no entry load (except the brokerage) and zero or minimal fund management charges because it’s a passively managed fund. “Expense ratios are typically lesser. Eventually, investors in India too will benefit once the liquidity improves and more people take to ETFs. Besides, no one is ‘pushing’ the price,” says Manglik.

Precious Metal

Demat delivery (just like in equity) does away with the requirement of keeping the commodity in physical form, thereby making security a non-issue. Compared to the sharp increases in the prices of precious metals in previous years, the cost of demat is minimal.

Experts believe that futures have several advantages over ETFs in terms of leveraged positions and small margins, which effectively allows the investor to ‘buy’ the same amount of gold at a lesser ‘price’. “Rather than being a passive investor, it is better to buy through futures that allow you to take benefits of a fall in market prices as against ETFs, which are ‘long-only’ funds,” feels Shyamal Gupta, head, institutional Business at Kotak Commodity.

Delivery Route

Industry players believe taking delivery through futures is beneficial for people who want to buy to meet social compulsions. “One big advantage is that only the best hallmarked gold bars in the country are given as delivery by the exchanges like MCX and NCDEX and so purity is guaranteed,” says Manglik. But taking demat delivery has its own disadvantages. When the price goes against your position (price falls after you have bought) then you have to give the difference (known as MTM or marked to market) immediately to the broker. So, it’s advisable for those who don’t understand the dynamics of how the commodity market works to avoid buying through futures. There have been many cases in the past where individuals lost huge amount of money because of indulging in sheer speculation.

Diversify to balance

Experts recommend that you should hedge your risk by diversifying the portfolio. “It’s always a good ploy to invest in different financial instruments. So even if you are investing in gold futures or ETFs, it is always recommended to invest some part of your portfolio in other options to mitigate the risk,” says Vikas Vasal, partner, KPMG India, a renowned global consulting firm. Experts feel that gold, as a portfolio and risk diversifier, cannot be replaced. That’s primarily one of the reasons that today also all the major investors worldwide have 3 – 15% of their portfolio in gold.

Gold Talk

An ounce of gold has reached $800 for the first time since 1980. There is a perception among the people that the prices are running up due to festive season, but that’s not true. International factors like a weak US dollar and high crude prices have been the dominant reasons for price increases in recent months. Though experts widely accept that there’s no right time for investing in gold, some feel that as long as US economy is perceived weak and therefore the US$ is weak against other currencies and crude prices are high, gold will be seen as a hedge against crude-led inflation.

“The international geo-political situation remains tense. Asian countries such as India and China have fast increasing demand, and it’s unlikely that the prices will come down in the near term. Apart from demand being more than supply, a combination of above factors will ensure firm prices in the foreseeable future,” believes Manglik.

But Gupta has other thoughts. “Based on the fundamental and technical analysis, in the long run, say over a period of two years, gold prices are likely to come down,” he says.