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D.Muthukrishnan (Muthu), Certified Financial Planner- Personal Financial Advisor

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Gold- Some interesting thoughts

Posted by Muthu on April 14, 2011

Wishing you a very happy Tamil new year. 

There were technical glitches in the live telecast on April 12th resulting in frequent breaks and program ending before time.

There is always a next time!

Hope you would have all voted yesterday.

From 1991, I’ve not missed voting for a single assembly, parliamentary or corporation election.

Looks like, in the history of Tamilnadu, the voting percentage this time is going to be the highest ever since independence.

I don’t know who will win the elections. But election commission has already won the hearts of the people of Tamilnadu. 

Gold is always considered auspicious in many hearts. So let me touch upon the subject today.

First and foremost, I want to share an interesting data with you.

An ounce (31.10 grams or 3.9 sovereigns) of gold was priced at $19 in the year 1800.

The price was $38 in 1970. An annualized return of 0.4% if a family (for generations) has held on to gold for 170 years.

It’s current price is $1456. An annualized return of 2.59% during the last 210 years.

I’ve written before how gold prices fell from $892 per ounce in 1980 to $272 in the year 2000. A fall of around 70% in value over 20 year period.

Due to continuous bull run, the gain has been around 535% over the last 11 years.

I’m not against gold. It has a strong cultural and social need.

But it is definitely not a great investment. When there is a war or global calamity, gold has lot of utility as a medium of exchange.

When I did a program about gold in Sun TV, one client of us told me that what I say may be true for world but not for India! He challenged me that during the above period (1980 to 2000), gold has actually appreciated in value in India.

I checked the data made available in ‘Nanayam Vikatan’. As per it, the price of one sovereign (24 carats) in 1981 was Rs.1304/- and appreciated to Rs.3392/- in 2002. So the gold price while fell by 70% elsewhere actually rose by 260% (annual return of 4.44%) in India during almost a similar period.

I wondered how it is possible. Gold is a universal commodity and if there is inefficiency in pricing, arbitrage opportunities in the market would bring parity in the prices.

To be frank, I just wondered and didn’t dig it further then.

As you are aware, I keep reading a lot. It’s a daily habit. I happened to read an article recently in Moneylife by Debashsis Basu & Raj Pradhan.

While reading the same, I was able to immediately connect to the above client’s question.

One Dollar was worth Rs.8/- in 1981. Whereas the conversion rate was Rs.48/- in 2002.

There lies the answer.

Let me explain further.

When gold has depreciated by 70%, the rupee has depreciated by 600% in the same period.

So the gain we saw in the Indian market while prices fell globally was due to the depreciation in the value of rupee and strong appreciation in the value of dollar.

This further strengthened our illusion gold prices never fall.

What if the prices of gold fall again globally say by 30% and rupee conversion rate remains the same? We would also experience a fall in prices.

Again what if the gold prices fall globally and rupee strengthens, say Rs.40/- to a dollar. It would be a double whammy. The fall would be more.

Commodities like gold and silver generally have longer cycles whereas stock markets usually have shorter cycles.

This create the illusion the stock market are instable and gold is stable.

In stock markets the recovery also may be faster but in gold the recovery may be longer.

Globally it took 28 years to get the same price for gold (i.e.) the highest price reached in 1980 was again touched only in 2008. Zero return for 28 years! Adjusting for inflation, a severe loss of capital.

I honestly don’t know how long the current bull run in gold will last. All I can tell you there would be bear run followed by the bull run. As I mentioned above, both bull cycles and bear cycles may last for a very long duration unlike stock markets.

As an investment, never keep gold and silver at more than 10% of your total portfolio.

Two more interesting points I saw in the above Moneylife article.

Despite a strong bull run in gold, it has returned only 8.9% annualized return between 1991 to 2010. In the same period, Sensex has given an annualized return of 16% per annum.

Sensex has given almost double the rate of return over the above 20 year period.

Iridium or ruthenium is present up to 6% in physical gold available in unorganized gold market, resulting in impurity.

One more thing I want to add.

Even if you want to buy a gold coin or biscuit, there is a mark up price of around 5% to the actual price of the gold in the market on that particular day.

When you sell the gold coin or biscuit, there is a discount of around 5% to the prevailing market prices.

Forget about jewellery (where you loose lot more in the form of making charges and wastages), even in coin or biscuit, you end up loosing up to 10% in a two way transaction.

Buy Hallmark physical gold for social needs.

For investments, opt for a SIP route through mutual funds or buy ETFs on regular basis. The expense ratio is capped at 1.5%p.a.

Don’t make any lump sum investments in gold. Do only SIPs.

As SEBI is auditing the gold held by mutual funds / ETFs, one can be assured about the asset behind the security.

To repeat, in my opinion, it is not worth keeping more than 10% of assets in gold.

It is not a great investment option which is contrary to our popular belief.

3 Responses to “Gold- Some interesting thoughts”

  1. Prasanth Prabhu said

    Good article. People in India are obsessed with Gold.

  2. navin said

    the facts represented in this article make sense but common man is very scared today with what is happening globally.
    what if the paper money looses it value…see what is happening in Zimbabwe

  3. Vijay said

    As long as our custom exists, gold will always be ‘most wanted’. With our population set to cross China’s in Y2025, a small portion of gold for social needs is bloating up the figures that India consumes 30% of world’s gold. I don’t think most of the people in Jewellery shop are buying gold for investment purposes, whether it does bull or bear run, we have to make mangalsutra in Gold only, right. It makes difference when we need to take it to pawn broker!

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