Gold rush

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A STORE of value.
A STORE of value.

Chirag Mehta
Ashwin Shah

Gold has always held a place of pride in every Indian household. As the commodities boom began in the early part of this century, gold prices have also headed north.

With the international price surge, a lot of Indian families would have been pleasantly surprised had they revalued their jewellery holdings.

Yet, looking at the shorter term, gold in India has been giving a negative return in 2007, despite the good build up on the international scene. In 2007, gold priced in dollars gained almost 7 per cent and euro terms by over 4 per cent. But in rupee terms, it has lost almost 2 per cent. This may not seem to make sense, but it must be borne in mind that cross-currency rates also fluctuate. Over the past few months, the rupee has been appreciating (gaining in value) against the dollar.

As gold is traded internationally in dollars, any increase in the value of the rupee will push down the rupee value of gold. Simply put, the appreciation of the rupee against the dollar has been greater than the appreciation of gold. Since the beginning of the year, gold has gained close to 7 per cent internationally (in dollars), while the rupee gained around 8 per cent against the dollar.

Looking at the rupee, the reason for the appreciation is not too hard to guess. Like everything else, the price of the rupee is a function of demand and supply.

The `India story' is drumming up a lot of followers internationally. Eager to be a part of this growth story, especially when the developed economies are faltering in their growth, foreign fund houses bring dollars to India to invest. They sell these dollars to banks and buy rupees to invest. This leads to an excess supply of dollars and a shortage of rupees, pushing up the price of the rupee.

Under normal circumstances, the RBI would step in and print rupees and infuse them into the market. (A rising rupee is harmful to exporters and a significant portion of the economy is export driven.) In the long run, an appreciated rupee would not be sustainable.

Coming back to gold, the fundamentals of the metal are very strong. It is considered to be a safe haven and a store of value, especially in times of uncertainty. Prices tend to shoot up in times of war and high inflation. It had a high propensity to move in tandem with inflationary and geo-political concerns. On the supply side, production has declined to a ten-year low. Another key source sale by central banks is also slowing.

In addition to direct consumption (jewellery and industrial usage), gold demand is also increasing in investment circles. Gold-backed Exchange Traded Funds have been a runaway hit globally. Add the geopolitical concerns and the uncertainty of the economy and you have all the conditions for gold prices to rise.

International prices are trading at around the $680/ounce. level. Investors should look for a suitable opportunity and try to buy gold/gold ETFs if prices come down in the near future.

Over the medium to long term, they can expect to gain on two counts the appreciation of gold and the depreciation of the rupee.

(The authors are with Quantum AMC Pvt. Ltd. The views are personal and do not necessarily reflect those of their organisation.)

(This article was published in the Business Line print edition dated May 20, 2007)
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