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Thursday, October 14, 2010

Go for Gold – a guest post

Despite the title, this post has nothing to do with India’s splendid performance in the just-concluded Commonwealth Games at Delhi. I have been writing about gold’s chart pattern for the past few months, and have watched in amazement as gold’s price soared.

Those who have read those posts may be aware that I am not a great fan of investing in gold. Nishit’s views are the exact opposite of mine. In this month’s guest post, he provides logical arguments why investors should consider adding a fair chunk of gold – preferably gold ETFs – to their portfolios.

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The Gold rush has begun again. Gold has sharply increased from about $1250 per ounce to almost $1385 per ounce in a little more than a month. Why has gold’s price increased so dramatically and will the rise continue? Let us dig a bit deeper to come up with the answers.

But first, a bit of history. The California Gold Rush (1848–1855) began on January 24, 1848, when gold was discovered by James W. Marshall at Sutter's Mill, in Coloma, California. News of the discovery brought some 300,000 people to California from the rest of the United States and abroad. Of the 300,000, approximately half arrived by sea and half travelled overland. It sparked off a period of economic boom in America, and has been the subject of many movies.

http://en.wikipedia.org/wiki/California_Gold_Rush

Gold has always attracted mankind through the ages. Gold does not have many industrial uses; it is not edible; it does not give any returns on investment. Then why is it so attractive to man?

Since time immemorial, gold has been used as a currency. Till 1971, the US dollar was linked to the Gold Standard. The Gold Standard was a monetary system in which a region's common media of exchange were paper notes that were freely convertible into a pre-set, fixed quantity of gold. So, for every dollar the US government printed they needed to have an equivalent quantity of physical gold.

Once the Gold Standard was dropped, it lead to the debasement of the currency. The government could print as many dollars as they wanted, provided that there were takers for those dollars. Gold is primarily used as a hedge against inflation, something which can be used as protection in times of crisis, and has everlasting value.

There are several reasons why I am adding Gold to my portfolio:

1. Diversification

2. I have been noticing that Gold prices have kept going up in Rupee terms since childhood. As late as 2005, I had bought gold for Rs 6500 per 10 gms.

3. The debasement of the currencies by various governments. Some one has to pick up the tab for the profligacy of the Western economies. By printing more money, you simply are delaying the problem.

4. It is made in limited quantities and Gold is one metal which makes people go crazy. It’s not as if tomorrow you are going to find huge gold reserves.

5. Limited supply and the tendency of Indians to keep hoarding gold. I doubt if even 20% of the gold Indians buy every year comes back in the market.

In any investment, I also look at the downside. Gold is not going to be worth Zero Rupees. In the worst case it may fall by 20%. We have not yet entered the speculative blowout stage.

If we look at the gold chart from 1975, gold has gone up from US $150 per ounce to more than $1350 per ounce now. A gain of 800% (9 times). This factors in the booms of the economy and the recessionary trends as well.

au75-pres

With debt crises all over the world, it is not a bad idea to have some portion of one’s assets invested in gold. One can look at the Exchange Traded Funds (ETFs) listed on the NSE as a safe way of investing. This does away with the headache of storage and provides liquidity as one gets cash in 2 days by selling the ETF, like any stock.

Why did gold’s price spurt so dramatically in the last few weeks? It is clear that the massive ‘Quantitative Easing’ has not produced the desired results. The US Fed may pump in more money for ‘Quantitative Easing - Part 2’ and Gold will soar the moment the package is announced. I see price targets of US $1500 per ounce and even higher in the coming years. At least 20% of one’s portfolio should contain gold as a hedge against inflation and the madness of US government printing more dollars.

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The upward-sloping channel in the Gold Price chart above has a price target of $6000 per ounce!

Tailpiece: The movie McKenna’s Gold, starring Gregory Peck, is a wonderful depiction of man’s lust for gold. It’s a classic western.

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(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)

3 comments:

Achin Jain said...

800% from 1975 is a very long time. I think if we check few stocks (A group) they will give the same % returns in less number of yrs.
But i agree it is a good SIP candidate and and never going to zero.
But I also want to say that there is nothing that should lead to Gold Rush now except Govt bad policies which make Gold price to rise.

Vikram Madan said...

Interesting writeup, Sir.

I think women's lust for gold would be more apt! It seems 80% of all gold produced in the world is exported to India and China, and possibly ends up in the godrej almirahs of all the aunties out there, never to see the light of the day ever again!

That is quite a tragic destination for this beautiful element... that was created not on earth, but in supernova explosions in deep outer space, billions of years back, and millions of light years away.

If gold prices keep falling, maybe the aunties will take their gold out more often. It's a terribly unproductive asset, currently.

Subhankar said...

The guest post by Nishit appeared 5 years back - when gold's price was still rising in a parabolic arc. Since topping out in Sep '11, gold's price has been in a one-way downward slide.

It may make some sense to allocate 5-10% of one's portfolio in gold ETFs as part of an asset allocation plan. This is what the Oracle of Omaha had said about investing in physical gold:

"Gold gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head."