Archive for June 2014



ALL THAT GLITTERS IS NOT GOLD

Written by HARIKRISHNAN.T
0 comments

India’s current account deficit (CAD) for the January-March period narrowed sharply to $1.2 billion (0.2 per cent of GDP) from $18.1 billion (3.6 per cent of GDP) in the same period last year, which was also lower than $4.2 billion (0.9 per cent of GDP) in the October-December quarter of 2013-14.

 When we observe the figures of current account deficit, we could easily figure out reduction in current account deficit is mainly attributed to the reduction in gold imports, which amounted to $ 5.30 billion, lower than $15.80 billion in the fourth quarter of 2012-13. Thanks to the measures taken by the UPA government to control the import of gold by increasing the excise duty from 2 to 6 and eventually to 10.

So the question comes to everyone's mind is that is this measure to control the current account deficit by controlling the supply of gold is sustainable? The answer is obviously no. It is pretty much clear that although government has taken stringent measures to control the import of gold, the fantasy of Indian households towards gold as a safe haven to beat inflation has never receded. So the only thing we can do to curb the obsession of gold is not to cut the supply but to curb the underlying demand. How can we achieve that?



In order to find the ways to control the obsession of gold, first we have to consider why people are considering gold as a superior investment vehicle.

Traditionally Indian middle class investors tried and tested the following asset classes

Bank deposits
Equity and equity oriented products
Gold

Most of the people got their fingers burned by investing in equities.

The first reason was that most of the first time investors usually start equity investment at the tip of a bull market. The reason can be attributed to different media that gives much more hype to the stock related news. News like ‘Nifty touched all-time highs, investors wealth multiplied by several times’ obsess first time investors and they take their exposure in equities for the first time on the assumption that equities can deliver superior returns in a short period of time. This euphoria can be seen everywhere. But the investments that they make will be in overvalued stocks because bull markets will stretch the valuations of stocks to unprecedented levels and since they make most of their investments at the peak of a bull market, eventually they will end up in loss as graham said all the bull markets will eventually end in an unjustifiable bear market.

Second reason is that attitude of most of the people is that they need quick profit. While investing in equities they are not considering the fact that investment in equities means investment in companies and the profit won't come in a day or two.

Third reason is even though people have long term financial goals, they are unwilling to take short term losses which are apparent in equities.

Because of all these factors, people consider equity investments as an investment vehicle to lose money. As a result traditional savings methods like gold and bank deposits got much more exposure than it ought to be.

In the last decade especially in the past 4 years, our country has been experiencing stubbornly high inflation. Consumer price index based inflation is somewhere around 8 to 10 percent for the past couple of years. People realized that bank deposits that gave a mere return of around 7 to 9 percent will not be enough to beat the inflation. So the exposure towards gold increased further based on the assumption that gold can give superior returns which is capable of beating the inflation.

So coming to the central topic of this article, how can we curb the demand of gold or more precisely how can we reduce the exposure towards gold in one's portfolio thereby making our balance of payments much more stable? There could be many ways but in my view the most effective way is to encourage people to invest in financial products such as equity and equity oriented products, debt instruments etc. rather than in physical products, teach them about various financial products available, make them aware of the benefits of investing as well as the risk factors involved. Encourage them to save for long term. Also make them aware that investment in equities can generate substantial capital appreciation in the long run. As nation progress everyone should get exposure towards formal financial system. This exposure towards the formal financial system will eventually help people to understand the various asset classes and the benefits of investing in various assets and also the risk involved. So in the long run exposure towards physical assets will reduce marginally and the people will allocate more exposure towards equity. Thus the financial markets of our nation will flourish and it will definitely going help to help our economy in a positive way. I know this is not an easy task and it requires Herculean efforts from concerned departments. But we have to take short term pains for a stronger and incredible nation.

I firmly believe in the long run no asset class can give the returns which equities can give. Take the past 20 or 30 years of data and you will come to know. But past returns does not necessarily mean that it will continue in the future. But as an investor we should and have to believe in a better tomorrow :)

It does not mean that I loathe gold. What I believe is the exposure of gold in our portfolio should not exceed 10 percent of the total portfolio value.


So to conclude curbing demand of gold by cutting down supply is not an option in the long run, even though it may work in the short run. The effective way is to curb the demand itself by making citizens aware of the various financial products apart from gold.

Views are personal :)