The price correction in gold is an opportunity for policy-makers to educate the public on alternative investment options.

Over the last two years, policymakers have tried one gambit after another to curb the prodigious appetite among Indian households for gold. These have hiked the import duty on gold twice in the last one year. The anti-money laundering law, too, has been amended recently to provide for enforcement of Know-Your-Customer or KYC norms for any retail gold jewellery purchase valued at Rs 50,000 or more. Both measures have their limitations. Any duty hike beyond the current level is certain to trigger a grey market in gold, with its implications for internal security. Similarly, while the imposition of the KYC norms might, in the long run, widen the tax base, it is unlikely for now to dampen demand for the yellow metal. Rather than resorting to panic measures, the Government can actually draw consolation from the recent correction in global prices that presents an opportunity to educate investors about the true risk-return characteristics of the yellow metal. Policymakers should seize this moment to convince investors that financial assets are just as good in delivering inflation-beating returns.

The current year so far has been unusual, with gold prices declining by about 4 per cent in dollar terms after twelve straight years of gains. Growing indications of an American economic recovery, resulting in a rebound in the dollar and also equity and housing markets, have prompted institutional investors – including the likes of George Soros – to reduce their gold price-linked exchange-traded fund holdings. As they have reallocated their money to other asset classes, questions are being increasingly raised over the sustainability of gold’s decade-long bull-run. Even in the Indian context, the one-year returns of about 6 per cent on gold funds are no longer looking impressive, when compared with equity (8 per cent) or even debt funds (9 per cent).

This, then, opens up an opportunity for not only policymakers, but even financial product vendors such as mutual funds to demonstrate to investors that gold is neither a sure-fire nor a risk-free bet. They could, perhaps, kick-start an investor awareness campaign, showing with numbers how gold is subject to cyclical swings in returns just as equities or other commodities are, and price volatility can result in capital erosion in this case as well. If that helps convey to investors, the risk of loading one’s portfolio with excessive amounts of gold, they may well be tempted to look at alternative avenues for parking their savings. After all, ‘investment’ demand for gold, whether in the form of bar, coin or paper, has accounted for well over a third of India’s annual gold consumption in recent years. If historical trends in savings are any evidence, investors in India are return-chasers and they actively re-allocate money to the options delivering the highest returns in the recent past. Policymakers could also use this moment to push ahead with the launch of inflation-indexed bonds, similar to the Treasury Inflation Protected Securities or TIPS offered in many developed markets.

(This article was published on March 15, 2013)
XThese are links to The Hindu Business Line suggested by Outbrain, which may or may not be relevant to the other content on this page. You can read Outbrain's privacy and cookie policy here.