Gold losing sheen

 

For the first time since ages, gold price has fallen year on year. Most of the current generation has never seen gold prices falling. Is this a temporary change or is it a longer term change? What are the reasons for us to believe that this is more long term and not just temporary and vice versa? Should we invest in gold or should we stop looking at it as an investment tool?

 

Trying to answer these questions is somewhat tough, though lets look at the fundamental reasons behind gold purchase and the motives behind investing in gold.

 

Firstly, with the Fed ending the QE, the price and value of money is more or less likely to increase. As in, within the next couple of years, if there are no major economic shocks, the interest rates in US will start moving up and hence there will be higher value in investing the money in banks. The major reason why gold was competitive to investing in banks was because of near zero interest rates and the attractiveness of gold as a physical asset. With Fed leading the way, it is more or less likely that sooner or later, other countries will also start increasing their interest rates to protect their currency and also to control inflation. These include the ECB, BOJ and BOE as the most substantial ones.

 

This would lead to lesser lucrative nature of gold investment as compared to holding bank fixed deposits or term deposits. Besides, the emerging world is severly fighting inflation and currency crisis and is highly unlikely to aggressively reduce rates and hence will rather have higher value to investing in term deposits v/s gold.

 

On the other hand, with India curbing gold consumption aggressively, the consumption demand for gold is also going down which leads to further less upside in gold prices. Besides, gold is also a hedge against inflation. But this relationship has gone down as over the years as the application of gold in industries as well as medicine has gone down considering its high prices. So the inflation hedge funda of gold has also been broken down. 

 

The next reason for holding gold is that it is considered safer than holding other currencies as it is independent of economic situation of one particular country but is dependent on global economy. However with more and more banks and more and more part of the world using dollar as reserve currency and constantly building reserves, it is more or less likely that any failure of USD will lead to a global crisis which will happen only if all the world central banks go out of firepower as now none of the banks and not just Fed can afford USD to fail. Hence such a crisis looks to be very unlikely and if it does happen, then it will be mayhem in global financial markets.

 

I have heard most investors in India saying that we should invest in gold as gold prices never go down. They keep appreciating but if there are couple of years when they see prices falling year over year, this sentiment is likely to change and hence investment in it will slowdown even more severly.

 

Looking at this scenario, it appears that investing in gold heavily is definitely out of window. Investing in gold in milder proportions - approx 5% - 10% of the portfolio is wiser as it can help you avert a major crisis situation which is more or less very unlikely. Hence people who have invested in gold as around 40-50% of their portfolio should rebalance it and get that value below 10% to approx 5%. The rush for gold is dwindling and its good to look at it with cynicism and avoid the thought " Gold prices always go up"