Gold emerges as a safe haven for investors

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Sushma Ramachandran | 16 Dec, 2009
With gold prices hitting new highs, the glitter just gets brighter each day. The phenomenal rise in the value of the yellow metal has been a by-product of the global recession as investors, both in India and abroad, are looking for safe products in which to place their funds.

With the dollar weakening and the US government deficit still to be reined in, international investors have preferred to put their faith in the yellow metal and this has led to a rapid rise in its value. International gold prices are hitting historic highs of about $1,200 per ounce, while in India prices touched a record Rs.18,000 but currently ruling at around Rs.17,600 for 10 grams. The value has risen over nearly 35 percent over the last year and the fastest pace of increase has been in the last few months.

The Indian government made its contribution to high gold prices when it bought 200 tonnes of the metal from the International Monetary Fund in October this year, a move that hit the headlines in the world press but merited just a few paragraphs in the domestic print media. The very fact that India sought fit to buy as much as 200 tonnes gave rise to speculation that this country was losing faith in the power of the dollar to prop up the global economy.

The weakening of the dollar against most major currencies has undoubtedly been one of the major factors leading to the rising price of gold. The dollar depreciation is largely due to fears over the growing deficit of the US government. Global investors are worried that the world's largest economy could be at risk of going into crisis mode once again.

The weakening dollar has also led to proposals from many countries, including India, China and Russia, that the world's financial system should no longer be pegged to just a single currency like the dollar. It has been suggested that a multi-reserve currency system should be in operation. The Chinese yuan is a contender for being one of the world's reserve currencies. Currently, the only reserve currency is the US dollar.

In this situation of a flux over currency issues, international investors have rushed to the relatively safer haven of commodities. Oil prices, for instance, have always risen steeply every time there is a credit crisis. Among the commodities, however, gold has been given pride of place.

The metal has traditionally been viewed as a hedging option when there is a downtrend in the economy. No wonder then investors found solace in gold during the recession that began a year-and-a-half ago. This focus has pushed gold prices up to record levels, but some commodity experts are expecting prices to rise even further in the months ahead. With prices now at nearly $1,200 per ounce, their projection is that these could go up to as much as $1,500 per ounce.

At the same time, there is no consensus even among commodities analysts on the prospects for gold prices in future. Some believe gold prices have reached their peak and a mid-term correction is on the cards. There are others who are extremely sceptical about the value of gold as a long-term investment. They point out that gold prices had actually declined from a peak of $800 in 1980 to reach $250 per ounce in 1999.

It has taken 10 long years for gold to once again reach the peak of about $1,200 dollars per ounce. Thus in the long run, they estimate that investing in gold might just about be sufficient to protect the investor from inflation.

In any case, the fact is that gold prices right now are at phenomenally high levels. In India, gold in the form of jewellery is traditionally bought for women to tide over a rainy day. The net result is that it is one of the biggest retail consumers of gold in the world.

With rising prices, however, there has been a rapid fall in demand for gold in this country. According to data available with the World Gold Council, demand in India dipped to 264 tonnes in the first nine months of 2009 as against 553 tonnes over the same period in 2008. Gold imports have also fallen drastically and are estimated at 173 tonnes during the period from January to November 2009 as compared to 417 tonnes in the same period last year.

As a result, the Chinese have recently overtaken Indians as the biggest retail buyers of gold. According to metals consultancy firms, demand for the precious metal in China is expected to rise to 432 tonnes in 2009 as compared to 422 tonnes from India. The high prices have been a dampener for Indian buyers who mopped up as much as 713 tonnes in 2008.

In the past, efforts had been made by financial institutions to lure Indians away from investing in gold and encourage them to shift to other products like stocks, bonds or real estate. Several gold exchange-traded funds have also been launched and proved extremely popular. But the demand for gold has always remained strong and India has been the largest consumer of gold for many years.

Right now it may seem as if those who stuck to gold might have been on to something, given the runaway rise in gold prices. At the same time, one must underline the fact that gold cannot be viewed as a productive investment in the long run. The highs being recorded now may not last long.

As soon as a strong global reserve currency or group of currencies are set in place in the global financial system, investors may lose interest in gold to some extent. But the precious yellow metal will never lose its lustre completely as it retains the image of being the asset that can tide you over times of dire necessity.

* The author is an economic and corporate analyst. She can be reached at sushma.ramachandran@gmail.com.
* The views expressed by the author in this feature are entirely her own and do not necessarily reflect the views of SME Times.