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S. Balakrishnan

India’s recent purchase of 200 tonnes of gold from the IMF marked its definitive transition from a forex deficit to surplus country. Although worth just about $6-7 billion, constituting barely 3 per cent of reserves, it sent a message that the governments and central banks of emerging economies can no longer be taken for granted. They want, their reserves away, as much as is prudent and possible, from the US dollar.

As usual, the ball was set rolling in the matter by China, the new heavyweight in the world economy. With its coffers overflowing with $2 trillion of reserves, China is on a desperate asset diversification chase.

It’s most unhappy about the predominance of US Treasury bonds in its portfolio. The Fed’s keeping interest rates near zero and bond yields are 3 per cent with high interest rate risk if inflation reappears and the US budget deficit keeps going up. Further, a consequential or independent depreciation of the dollar will make things worse.

Gold was the obvious hedge against the massive reflation in progress the world over, despite it being considered a ‘barbaric relic of yesteryears’. It not only offers no yield but also costs money to store. Yet it’s risen nearly 50 per cent in less than a year, that too at a time when inflation (at least in the rich economies) is extremely low.

The sharp rise suggests China embarked on its gold buying well before India even thought of it.

There are two diametrically opposite price forecasts for gold — both from pundits with track records to boast of. Jim Rogers, who foresaw the commodity price boom, predicts gold will touch $2000 as the market takes fright at the state of the US economy and public finances and drives down the dollar.

Nouriel Roubini, who correctly called the sub-prime mortgage crisis and the crash of financial markets and venerated financial institutions, calls Rogers’ prediction ‘nonsense’.

The battle has, thus, been well and truly joined.

Though a late mover, India’s purchase is wise, given the extreme volatility of the dollar as well as other global currencies. The investment has already turned a paper profit for the RBI as the price of gold is up about $100 in the last fortnight.

The search for less risky assets in which to hold reserves will continue.

Some role is already being assigned to the euro and the Japanese yen but there’s a clear limit. Commodities are, therefore, likely to find increasing favour. As an analyst remarked, unlike currencies, they are not anyone’s liabilities.

Don’t be surprised if the reserve basket of the future comprises copper, aluminium, wheat, rice and sugar, apart from the dollar, euro, yen and gold.

More Stories on : Metals | Forex | Commodities | Financial Scan

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