October 17, 2006, www.rediff.com, Co-author-Aditya Jadhav
Diwali being just a few days away, the sale of gold ornaments, coins and bars are already going up. So is the price of gold. However, contrary to popular belief, gold is still a very cheap buy when compared to many other commodities. When adjusted against inflation, gold is just about as expensive as it was in 1980.
India is the largest consumer of gold in the world, consuming around 18 per cent of the total world's production. India has to import around 70 per cent of its total gold consumption, thus imparting a lot of foreign exchange to major gold producing countries.
With the development of the stock markets, especially on-line trading systems, urban India is slowly shifting its investment focus from gold to the other avenues of investment such as stocks, bonds, mutual funds, et cetera.
But, rural India still has its major investments in the form of gold. Around 65 per cent of the total demand for gold in India is from people involved in agriculture and allied industries which contributes to around 30 per cent of the GDP of the nation.
An effective hedging tool
Gold provides an effective hedge against inflation. Gold prices are considered to be highly sensitive to inflation and rise accordingly. Gold also provides effective liquidity higher than other forms of real assets like gemstones, land and antiques which require some time to get liquidated.
The only problem that arises with the liquidity of gold is its resale value in the form of jewellery. Jewellery requires gold to mix with a little amount of other base metals like copper and zinc which reduce the purity of gold and hence gives lower returns than pure gold (99 per cent pure) of equal weight.
Oil price impact on gold
The demand for gold also goes up with an increase in oil prices. Increase in oil prices have a major impact on inflation as most of the inflation indices give a lot of weight to the increase in oil prices (30-35 per cent). Hence, increase in oil prices result in an increase in inflation.
People buy gold to hedge against inflation. Oil prices have been on a rise and will continue to be on a rise with the increase in demand for fuel, plus, recently Organisation of Petroleum Exporting Countries (OPEC) has given indications that it will curtail the supply of oil.
Commodity trading and gold
With the opening of the commodities market for gold, gold futures has become another mode of investment in gold. Although this avenue is not as extensively used as spot purchase of gold or the securities market, gold futures do impact the spot prices of gold, as the wholesale traders have started to use this avenue to hedge against future price changes.
Gold is different from other commodities traded on the futures market, as the consumed gold can be brought back into the market (though at a discount) unlike other commodities. This creates a situation where the current demand and price of gold is not only dependent on the current purchase, current demand and future demand but also on the past purchase and demand.
Gold is the only commodity in which the total supply can be higher than the demand making the trading of this commodity unique.
Gold is not just a mere investment for Indians. It is woven into the fabric of the Indian culture, traditions and religious beliefs. There is a popular Jataka tale where a poor farmer donates a gold cat to the Brahmin to get rid of the sin of killing a stray cat. The farmer has to take a loan from the money lender for this purpose resulting in the ultimate forfeiture of his land by the money lender.
Women are the majority users of gold ornaments in India. Parents give their daughter gold ornaments during her marriage which is her exclusive property (streedhan) and not to be used by the husband for his personal gain without her permission.
Gold is also a status symbol helpful in asserting the status of a person in the society, especially in India. The importance attached to gold, along with its scarcity in the earth's crust compared to other metals, and its ability to provide a good hedge against inflation, makes it a highly demanded precious metal. The demand ensures that the prices will surely look northwards in the future too.
So, this Diwali, invest in gold without worrying about the prices being too high!