All about gold

The Rise, the Fall and the Future

MARKET MOOD

EJAZ AYOUB

One of the recent crises in commodities markets which has sent a chill down the spine of many investors and traders is the downfall of Gold prices. Indians and likewise Kashmiris are obsessed with gold since Adams era particularly because of its importance and exchange in weddings. Although we as “non-investors” always welcome the falling prices of gold, but there is huge class of investors who use gold not only as luxury and wedding gifts but as a very secure option of investment particularly with Gold’s time tested ability to hedge inflation. There is a strange suspense going in the markets and people are very ambiguous about the future behavior of gold prices. So what do the numbers say?
Historical Trends:
Gold prices at international levels have risen exponentially in the last decade. The international gold prices have grown at compound annual growth rate (CAGR) of 16.3 per cent since 2000. Gold prices in Indian markets have also moved in tandem with international gold prices. The following data shows volatility in gold prices in recent quarters is positively skewed implying that it provides fewer large losses and a greater number of larger gains.                    
The Rise:
One of the major components of gold demand in recent years has been “investment demand” at the global level. Inflating gold prices in recent years did not deter the demand for yellow metal in India, showing that investment in this metal is becoming price inelastic. If we look at the trends in Gold Price, its only after 2004-05 that gold has started giving very sharp returns. It has given more than 20% annualized return since then. Apart from Gold’s ability to hedge against inflation, gold has this amazing ability to rescue an investor during a catastrophe. Compact and convenient to transport, it’s the one commodity that you can expect to be valuable no matter the political situation. Simply put, gold is a great bet if you think there’s going to be a revolution.
Gold has held a pivotal role in international monetary policy from the early 19th century until 1971. Gold standard — a system in which national currencies were ultimately redeemable for a fixed amount of gold — was followed by major part of the world economies until 1971, when Richard Nixon formally severed the convertibility of the dollar and announced a series of economic measures what we call as the “Nixon shock” and ended the “Bretton woods System”. Since then, economies across the world have been in the peculiar position of having their currency backed by nothing more than faith. For instance, under this system, India could theoretically print and spend money endlessly, with no fear that its spending of Rupees would deplete its stock of gold.
After 1971, this era of “floating” currencies has been a driving force in developed countries’ ability to take on more and more debt, a phenomenon that has reached new highs since 2008 crisis. The rise of gold in recent years can be explained in part by investors’ understandable lack of confidence in governments’ ability to keep their debt under control, and therefore the value of their currencies high. In fact, central banks across the world in recent years have also diversified their holdings into gold as a hedge against a decline in the value of the dollar.
The Fall:
It’s really difficult to figure out the exact cause of any market correction, and analysts have come up with a range of possible underlying reasons, from the Cypriot central bank’s need to sell off some its gold reserves to pay for its bailout to recent trends showing a slump in gold purchases by the Chinese economy. Most assets are valued in anticipation of the aggregate discounted cash flows, but undoubtedly gold produces no income. It has no financial outflows except for the fact that humans have always valued it. Due to this difficulty of pinpointing the gold’s fundamental value, nobody knows for sure as to why gold is declining in value. The severity of the recent dips in gold is surely the outcome of gold’s ambiguously defined value. If someone has invested in gold primarily to save his wealth from inflation burn, It does provide a logical insight as to why a slight dip in its value can make sellers run for the markets. This only catalysis the severity of the dip and the cycle only worsens.
There are also questions being raised against the survival of the current monetary regime of “floating currencies” which is in its fourth decade. Historically “Bretton woods” monetary regime lasted for less than 30 years and the classic-gold standard lasted just 4 decades. All these factors and historical events tell us that change is going to come; the hard part is figuring out its magnitude, shape and exact time.
The Future:
If as an investor your prime objective for investing in gold is to hedge against inflation than I suggest that there are far better options which offer similar benefits with toppings of being safe and easier to value e.g. recently introduced inflation indexed bonds. Now, looking at a number of factors ranging from the issues cropping up with “floating currency systems” to sustainability of dollar’s role as the world’s currency, the world’s oldest currency Gold may have yet another role to play in the ongoing history of money which brings us to the collective wisdom of continuing investment in gold.  So, let’s not mistake recent decline for the end of the gold Bull Run. The Gold Bull is going the stay.
(Ejaz Ayoub is a Risk Analyst)
ejaz.ayoub@gmail.com

Lastupdate on : Tue, 30 Apr 2013 21:30:00 Makkah time
Lastupdate on : Tue, 30 Apr 2013 18:30:00 GMT
Lastupdate on : Wed, 1 May 2013 00:00:00 IST




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