Is this a good time to invest in gold? – a guest post

After a decent rally from the low touched in Jun ‘12, Sensex seems to be stuck in a range – neither moving up much, nor falling down. Retail participation has been low. Those who missed the rally may be waiting for a deep correction to get in. Others are probably waiting to jump in once the index hits 20000.

In this month’s guest post, Nishit argues in favour of gold as an investment avenue because the domestic and global economy is in doldrums.

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Gold in Rupee terms has given just about 5-6% return in the past year. Now is a good time to look at the future prospects of Gold as an investment.

The Gold we buy in India is dependent mainly on two factors: the price of Gold in US Dollars, and the exchange rate of Indian Rupee vs. US Dollar. It is a big myth that price of Gold goes up during the Indian wedding season. Even though India is a large consumer of gold, there are other global factors driving the price of Gold.

What has been happening in 2012 is that the price of Gold in US$ and Indian Rupee have been going in opposite directions. When Rupee weakened to the 56-58 range, the price of Gold fell in Dollar terms. Also, when price of Gold rose in US$, the Rupee also strengthened.

Fundamentally, Gold is treated as a safe haven. Whenever there is a global crisis or if economies go bankrupt, the attraction of Gold goes up. 2012 was a relatively stable year and hence the price of Gold is stuck in a range between US$ 1550-1800 per ounce.

The US fiscal cliff and Eurozone sovereign defaults - if and when they happen – will cause the price of Gold to rise. Another benchmark for gold is how many barrels of oil can be purchased by 1 ounce of Gold. Currently it is about 16 barrels, which is the long-term average. If oil’s price begins to rise, gold’s price will also rise.

The exchange rate of Indian Rupee is dependent on foreign inflows. Once the inflow dries up, the price of gold will start going up in Rupee terms.

So, the price of Gold for Indians is dependent on:

1. Rupee (watch the FII inflows)
2. Price in US$ (watch related commodities like crude oil, and foreign economies)
3. Performance of Dow Jones and other foreign indices

Also, just to slip in a bit of technicals, US$ 1800 has been a resistance level for more than a year and hence, expect a rally when gold’s price closes above 1800 for 3-4 days.

For the price of Gold to rise in the current scenario, the global economy has to either weaken or boom dramatically for speculation to take place. A boom seems unlikely and hence the most likely scenario is the Western economies slipping down into recession again.

One should be invested in Gold to the extent of 10-15% of one’s portfolio. It acts as a hedge against inflation simply because it guards against Rupee weakening. Once upon a time, when Rupee was strengthening and the exchange rate was heading towards Rs.40 to US$ 1, it did not make sense to add Gold.

If the Indian economy does as badly as in late 2011, it may be sensible to add Gold. In a nutshell, whenever any economy is doing badly, either domestic or global, it is a good time to invest in Gold. Even in 2008, Gold’s price shot up after the equity markets tanked.

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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).