FOOL’S GOLD

The other day I was sipping my Scotch and Soda at the club when Mr Prasad spotted me. We exchanged pleasantries and then he started enquiring about gold ETFs and investment in gold as an asset. I said, “Sir, Gold as a real return generating asset does not match up with real estate or equity. I would not advise you to buy gold ETFs.” The problem with free advice is, because it is free, it appears worthless. And no one is to blame for it, because 99% of humans are psychologically tuned to think “Expensive is Good”.   

Secondly, we Indians are a high context society. If one does not take half an hour to explain and then ask some questions, useless as they may be, the other person is not convinced. A case in point is my wife. She decides the competence of a doctor by how much time he spends with her, asking about her dog, her kids, her shopping and then her ailment in that order. If the doctor asks her the problem and straightaway writes a prescription and says next, she writes off the Doctor. She says, “The doctor does not know anything. How can you decide in one minute what is wrong with me?” I always smile quietly, at her methodology, I dare not smile in the open. But it is true. All of us do that, sometime or the other.  

Mr Prasad also took my advice with a pinch of salt.  Our conversation went something like this. “Yaar, how can you say Gold does not give good returns. My wife bought gold  when we were in Jammu at a very low price and see today it is Rs 32000 for 10 gm.”  I asked him,  “Can I know the year and the price? May be then I can convince you?” He immediately rang up Mrs Prasad and asked her. They had purchased some gold in 2002 at Rs 4800 a tola (10 gm). I did some Mental Math and told him that it would be approx 17 % or so.

“See, that’s a very good return.” I said, “Yes, but in the last five years  so much of  speculative interest has been built in Gold which is giving this unsustainable return and this is bound to taper off. It will then come to the normalized returns which are approx 10% CAGR”. I have  maintained  a view that Gold as a long term investment only gives 1-2% more than inflation, sometimes just keeps up with inflation. Thus, it does not give much of  real returns. I only buy gold for my wife, if she wants to wear it. Never as an investment.

I told him to please extrapolate over a 20 year period to know the exact returns.  I then did some research. I gleaned out some data from the Reserve Bank of India site. I got data from 1970 onwards only.

 I wasn’t too much off the mark, on my straight from the hip advice to Mr Prasad. The return in last decade was a CAGR 18.8%

What has happened in the past decade and past three years to be precise?  I can fathom two main reasons. One is the speculative interest in Gold. It will come down in the near future. Everyday Gold prices are on the cover page of newspapers. Whenever, any financial issue makes it to the cover page of a newspaper, it implies there is a speculative bubble building around that activity. Remember, the stock markets also give similar returns in the final phases of a bull run, when speculation is rampant. 30-40% returns a year,  close to the end of the cycle.

On top of that, the Gold ETFs are contributing to this vicious cycle. The common man thinks that gold is giving a good return and the Gold ETFs are a good vehicle to ride on the gold boom. They go and invest money in gold ETFs. The corpus of funds managed by Gold ETFs has  thus, increased in the last ten years in a humongous way, and the Gold ETFs can only buy gold with this. So, they are also buying gold. And the common villager in India has since times immemorial always bought gold for marriages, for security and for safekeeping, thus he also hoards gold. As a result, more money chasing gold has led to this bubble in prices. At current prices, demand will taper off. When a commodity becomes unaffordable, people look for substitute products. Students of economics will know this better. Silver is a cheaper substitute for the poor. And for the rich, diamonds are the substitute. Therefore, gold as a commodity will see lower prices and the returns will revert to the mean at some stage.

The second main reason for gold prices moving sky-high is the endemic corruption in India. Corrupt Indians have amassed crores of wealth through foul means. It is very difficult to move 5 crores of cash from place A to place B. But very easy to move 15.5 Kg of gold. It is also easier to stash away from prying eyes of the CBI/IT departments. So, a corrupt India buys gold for its own reasons.

Now, if you still wish to invest in Gold ETFs, please go ahead and do it. Who am I to question your wisdom?