Can You Invest in Gold ?
Below is the chart( click the image for a better view) of different asset classes compared with each other on the logarithmic scale.
- Equity and Gold have moved in opposite direction since 1970 .
- Commodities including Gold, Copper and Oil have moved similary ( the linear trend ) .
- US dollar moves in the opposite direction to gold (negative correlation is lower) but gold has moved more steeper in the upward direction in the recent past against the dollar.
- Peculiarly, all the asset classes have been in the uptrend barring the dollar after a large infusion of liquidity in the global markets since the Fed cut the rates to 100 bps in 2001 .
Investment Corrolaries
Gold is a hedge against the dollar, it is presumed that it is better to invest in gold as it yields a higher return compared to the US dollar assets which would yield negative or paltry return (Fed has been aggressively cutting rates and is expect to come to 100 bps mid this year).Lower interest rates result in the depreciation of a currency (investors sell the currency with the lower interest rate and buy currency with higher interest rates{the supply demand theory} hence spot rates of $ has been tumbling) and the Fed is not expected to increase the interest rate again before growth picks up in the US.US is expected to get into a recession and feel the brunt for at least the next four quarters. Thus a sharp reversal in $ trend is not expected until next year, assuming US gets into a recession now.
Fed is expected to cut rates; as a consequence, liquidity is expected to be at higher levels once the credit crisis subsides, this should logically fuel the prices of all asset classes. Now if US gets into recession the equity class would not perform and it is widely expected that S&P 500 would fall by 20% if US gets into a recession, so ideally going by past, gold should be bought as an alternative to equities.
Commodities are expected to outperform given the demand supply mismatch due to huge demand from developing countries (esp China & India) but the real question is whether slow down in US & developed world would reduce the demand and hence reduce the deficit and hence result in a cool off in commodity prices.
To invest in gold or not now ?
Gold & commodities in my view are at least 10-15% below their peaks, so ideally, they must correct or reverse the trend after it. The real state of US economy must be clear by Q3 2008, so ideally any new trend should happen then. If the US Equities correct by 10-15% by then and economy picks up, we can be almost sure that the trend is going to reverse. That is when Fed should ideally start increasing the rates and dollar must see any reasonable strength. This would bring back the confidence in the dollar and investors must flee gold.
The risks to the above conclusions are that the US might enter into a stagflation environment (the US GDP/prices falls even though there is a steep increase in inflation/ cost of input materials which cannot be passed on to the cosumers as there is a lack of consumer demand in a recessionary environment).The probable reasons should be that commodities demand supply gap is persistent and the prices do not come down. This is a good scenario for considering gold as an investment.
If US shows the middle finger to the recession scare and returns to throttle in another two quarters, then gold would correct sooner or later.
It all depends of when uncle Sam is expects to come back with a bang.
Labels: economics
On the back of a good post from Sara,I would like to suggest a investment opportunity in the DSP Merrill Lynch World Gold Fund*** for those who wud like a mutual fund exposure. This funds invest in another fund called Merrill Lynch International Investment Funds – World Gold Fund that invest in Gold mining companies.The funds has exposure to precious metals mining companies like Gold,Platinum,Silver,Diamond based across the world.
For those who wud like to invest in the real gold the advise wud be to get into ETF (Exchange Traded Funds).The gold bars and coins that you get in Banks and Jewelery shops have liquidity constraints as you cannot sell immediately and moreover banks do not buy the coins or bars back even though you wud have bought it from them.
Happy investing
*** The name might have changed to Blackrock after the M&A activities.No change in fund management.
Posted by
Pramod Abraham |
8:45 am
Sara..Playing the devil here.
While the analysis is very clear in its path, we would need to understand that we are in a road never travelled and the global scenario has changed dramatically during the past decade or so. Some changes relevant to your post, which would suggest Gold as not such a safe investment:
1) Comparing Dollar against the Gold today is not really correct. The last decade or so is the one when economies have opened up and there has been globalisation in the true sense. Free float of currencies need to be considered thus.
2) Dollar is not the 'measure' now that determines the worthiness of asset classes. It is one among the many metrics with relevance going southwards. ( especially with Euro gaining in prominence ). On a lighter note, do we now consider dollar an asset or a liability ?
3) The Real demand of Gold is only a fractional determinant of its price. The Growth of derivatives with Gold as underlying - Gold ETF's etc have jacked up prices using the same analysis. Infact the previous comment by Pramod is a case in point. Banks and hedge funds have taken huge long positions in Gold . Just walk in to your nearest jewellery shop and you will realise whether people are buying or actually selling gold ( i did this last week ! ) .Its a case of the virtual driving the prices of real , rather than the other way around.
But sooner than later, this bubble is gonna burst too. Think about it, on one hand, we are saying liquidity crisis ( and worse - solvency issues ) across economies and on the other hand we are saying people investing in Gold at these prices -> sounds strange to me :)
Posted by
Bhatter |
11:14 am