Gold prices recently touched a 6 year high as it got beyond the $1550/oz mark and threatened to get closer to the $1600/oz mark. Of course, subsequently, the price of gold did correct to below $1500/oz. People tend to ask whether this is the right time to be buying gold or whether they should wait for lower levels. Of course, gold is still below its all time high levels of $1900/oz, but the case in India is quite different.
Even as global spot price of gold touched a 6 year high of $1550/oz, Indian gold prices crossed the life time high of Rs.40,000/10 grams. Consumer demand for gold has fallen sharply due to high prices. In fact, during the June quarter, the gold imports fell by nearly 70% on a YOY basis due to the sharp spike in gold prices. Apparently, people are not too comfortable buying gold at the current price levels. That is because; In the last one year alone, the price of gold in the Indian market has rallied 30% from Rs.31,000/10 grams to Rs.40,000/10 grams. This makes the dilemma a lot sharper; should they or should they not be buying gold?
What you need to understand about the unique aspect of gold
Gold demand comes from various avenues. Nearly 70% of the gold demand comes from jewellery, aesthetics, gifts and gold coin purchases. The balance is accounted for by ETF buying, central bank buying and a very small portion of demand arise from industrial applications. Gold has always been an essential part of any portfolio. Here are some facts you need to know before taking a call on gold.
- The difference between global gold and Indian gold prices is largely due to the weakening of the rupee. Since gold prices are globally denominated in US dollars, any weakening of the dollar increases the rupee gold price. Between 2011 and 2019, the rupee has weakened from 48/$ to 72/$ and this 50% rupee weakening explains why rupee gold is at a high while dollar gold is still below its peak.
- Indians hold an atrociously large amount of gold either in jewellry form or as ingots or even as coins and dollars. With domestic gold prices up by 30% in the last one year, there is a wealth effect in gold holdings in India. Indian households possess gold to the tune of 22,500 tonnes (that is huge). We are only talking about households and are not even counting the gold in the temples; which could another humongous sum. Can you imagine the value of this household gold? For example, 22,500 tons of gold translates into 22.50 billion grams of gold. Considering that the Indian price is currently Rs.4,000/gram that translates into gold holding value of $1.25 trillion. Since gold has appreciated by 30% in the last one year, it has resulted in gold wealth creation to the tune of $260 billion in the last one year. Against this wealth creation, the loss on equity holdings is marginal.
- Gold has been the preferred choice in times of uncertainty due to its special relationship with uncertainty. Normally, greater the global uncertainty, higher is the price of gold. Today, global uncertainty is elevated due to a number of factors like the trade war, BREXIT disruption, China slowdown, prospects of currency war, risk-off investing etc. In these conditions, gold emerges as the best bet. In fact, if you look back in the last 50 years; between 1971 and 1979, gold prices rallied 25-fold on the back of global uncertainty. That is the kind of return, few other asset class have given in the last century.
- How do you allocate to gold? Ideally, gold should be a part of every long term investment portfolio in the range of 10-15%. Essentially, gold provides a solid hedge in uncertain times. In times like these, it makes sense to push the allocation closer to 15%.
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There is only one thing you need to be cautious about when making a case for buying gold. The gold/silver ratio is an important input and that is at 82.89 which is close to its historical high of 100X. In 2011, that ratio had fallen to below 50X. Buying gold closer to 80X is empirically risky and that is what you need to be cautious about. Adopt a phased approach to buying gold each time the ratio gives you some comfort zone. Otherwise, gold continues to be a fundamentally attractive asset at this point of time.