Gold imports destroying Indian economy?

[asianobserve]

Gold: Bubble or Not?
Marc Schindler, 8/28/2011
Gold: Bubble or Not? - Forbes


This week GLD, a gold ETF, surpassed SPY, an ETF tracking the S&P 500, to become the largest Exchange Traded Fund. Gold prices also set a new all-time high. This should ring the bubble klaxon!

Gold is an useless asset. It does not produce earnings, it does not pay dividends or interest, and it has few industrial uses. The only things it does well is look pretty. So why is everybody buying it instead of stocks, bonds, rental properties, or anything else that does produce an income stream? There are two possible answers: Gold is undervalued even at its current price. Or herding behavior causes people to buy into a bubble.

The gold price has increased from $255 in August 1999 to well over $1800 today without serious dips or pullbacks. It is easy to see why this attracts investors, especially when compared to the turbulence in the stock market over the same period of time. It is also easy to see why people might expect that gold will continue to rise after watching it gain consistently for well over a decade.However, history shows that asset prices cannot continue to go up indefinitely. There are always pull backs, crashes, and bear markets. The last time this happened to gold is a distant memory, but we all remember recent examples such as the tech stocks in the '90s and home prices in the '00s.So is gold like the tech stocks or residential housing? As is often the case in finance, it depends on how you look at it. We recently posted about the how much S&P 500 earnings an ounce of gold can buy. By that measure gold is vastly overvalued compared to stocks. However, there are other ways to put the price of gold in relation to the rest of the economy.

The chart at left provides a few examples. We plotted the ratio of the gold price to the value of the S&P 500, to the GDP, to an index tracing industrial metals (i.e. those that are useful rather than just pretty), and to the median family income.

No matter how you look at it, gold was more overvalued in the lat '70s and early '80s. That was a time of double digit inflation and several recessions, which increased the appeal of gold. However, once the crisis was over gold fell steadily for about 20 years.

For the last decade, gold has been climbing again. In none of the categories has it surpassed its relative valuation peak from 1980, but we are getting close compared to the median family income and the price of industrial metals.
So what does all of this tell us? Well, we have the usual mess of contradictory economic data.
The size of the gold ETF screams bubble because it indicates that everybody and their dog have bet all on gold. The relationship between the price of gold and S&P 500 earnings also screams bubble. The gold price relative to industrial metals and personal incomes shouts bubble, but compared to the GDP or the S&P 500 index value it only a murmurs the question: "Bubble?"

Over long time periods, gold has been a terrible investment while stocks, bonds, and income-generating real estate have produced good returns. This is likely to be the case going forward as well.

Even if gold doesn't unambiguously qualify as a bubble, it is likely that price drops will be drastic when investors shift back into more sustainable investments. The sheer size of the gold ETF virtually guarantees that sellers will not be able to find buyers at current prices. Buyers will appear once gold has become cheap, but all of our ratios indicate that this would require a substantial price drop.

It is always easier to identify assets that are bubbling than to predict when the bubble will pop. Gold has much more downside than upside at this point, but this has been true for years without slowing price gains. Home prices and tech stocks also suggest that bubbles can exist for years even after objective measures (e.g. P/E ratios or rent to buy ratios) show that markets are out of equilibrium.

It is anybody's guess when gold will correct, but it is very likely that it will be ugly when it does.
​

 

[pmaitra]

If I am not wrong, the amount of gold a country has, the amount of money it can print. The economy grows.

Yes and No.

You may have any amount of gold and you can print as much as currency notes you want.

If you have less gold and print a hell lot of currency notes, you get this:

If you have more gold but print less currency, you get this:

 

[asianobserve]

Gold ETF - "Gold exchange-traded products are exchange-traded funds (ETFs), closed-end funds (CEFs) and exchange-traded notes (ETNs) that aim to track the price of gold. Goldexchange-traded products are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York. As of 25 June 2010, physically backed funds held 2,062.6 tonnes of gold in total for private and institutional investors.[SUP][1][/SUP] Each gold ETF, ETN, and CEF has a different structure outlined in its prospectus. Some such instruments do not necessarily hold physical gold. For example, gold ETNs generally track the price of gold using derivatives." Wikipedia

Gold ETFs Rake in Assets; Bullion Holdings Near Record | ETF Trends

 

[asianobserve]

Yes and No.

You may have any amount of gold and you can print as much as currency notes you want.

If you have less gold and print a hell lot of currency notes, you get this:

If you have more gold but print less currency, you get this:

The 10 Biggest Gold-Hoarding Countries In The World

 

[pmaitra]

Gold ETF - "Gold exchange-traded products are exchange-traded funds (ETFs), closed-end funds (CEFs) and exchange-traded notes (ETNs) that aim to track the price of gold. Goldexchange-traded products are traded on the major stock exchanges including Zurich, Mumbai, London, Paris and New York. As of 25 June 2010, physically backed funds held 2,062.6 tonnes of gold in total for private and institutional investors.[SUP][1][/SUP] Each gold ETF, ETN, and CEF has a different structure outlined in its prospectus. Some such instruments do not necessarily hold physical gold. For example, gold ETNs generally track the price of gold using derivatives." Wikipedia

Gold ETFs Rake in Assets; Bullion Holdings Near Record | ETF Trends

Exchange traded funds themselves may not physically hoard gold, but eventually, they own gold somewhere in the world. A one rupee note anywhere in the world still owns gold worth one rupee in India's reserves .

 

[pmaitra]

The 10 Biggest Gold-Hoarding Countries In The World

From the same link:

#10 India

Official gold holdings: 557.7 tonnes
Percent of reserves: 9.0%

India's gold reserves climbed to $28.05 billion, but the country's central bank gold holdings lag those of major economies. The RBI is known to buy IMF gold and considers gold to be a safe investment, but rarely comments on its plans to buy gold.​

Source: World Gold Council

Read more: http://www.businessinsider.com/gold-holdings-by-country-2011-12#10-india-1#ixzz1iXiDJMpt

LOL, India is the 10th biggest gold hoarding in the world, but that could be partly due to Indians buying gold for jewelry and also for burying gold bars when laying foundations for a new house.

<< Gold = Lakshmi >>

 

[asianobserve]

Note SPDR ETF has more gold than China, Switzerland, Japan or Netherlands... Who Owns Most of the World's Gold?

(Note: India is not on the top ten if non-country gold hoarders (ETFs) are included in the list.)

 

[asianobserve]

Exchange traded funds themselves may not physically hoard gold, but eventually, they own gold somewhere in the world. A one rupee note anywhere in the world still owns gold worth one rupee in India's reserves .

ETFs are gold-backed. It means that for gold shares that are sold and bought there actually exist a physical equivalent in their warehouse/s somewhere.

 

[pmaitra]

Note SPDR ETF has more gold than China, Switzerland, Japan or Netherlands... Who Owns Most of the World's Gold?

(Note: India is not on the top ten if non-country gold hoarders (ETFs) are included in the list.)

Very good observation. Yes, it is true. However, you need to count the general public, temples and other institutions holding gold too. I don't know if there is any way to compare non-government entities.

 

[pmaitra]

ETFs are gold-backed. It means that for gold shares that are sold and bought there actually exist a physical equivalent in their warehouse/s somewhere.

I see. Well, yeah, then of course. It could also be backed by gold in some country's reserves.

 

[asianobserve]

Very good observation. Yes, it is true. However, you need to count the general public, temples and other institutions holding gold too. I don't know if there is any way to compare non-government entities.

It's almost impossible to count/quantify gold coins, jewelries, bars stashed by individuals. What can easily be accounted for are gold held by institutions.

 

[pmaitra]

It's almost impossible to count/quantify gold coins, jewelries, bars stashed by individuals. What can easily be accounted for are gold held by institutions.

That's true.

 

[panduranghari]

Note SPDR ETF has more gold than China, Switzerland, Japan or Netherlands... Who Owns Most of the World's Gold?

(Note: India is not on the top ten if non-country gold hoarders (ETFs) are included in the list.)

Paper gold and physical gold are different beasts.

The world has enough paper gold. When gold price will fall to less than 200$/oz try buying physical gold, you will not get any.

 

[pmaitra]

Paper gold and physical gold are different beasts.

The world has enough paper gold. When gold price will fall to less than 200$/oz try buying physical gold, you will not get any.

You are correct.

Paper money can buy gold, but if there is real demand, then the price will rise again. When there is no or negative demand, i.e. people trying to get rid of their gold, then the prices will fall. When gold price falls to less than say $200/oz, you will not get any, but if you really want it, you will be willing to pay a slightly higher price and you will get it, and in the process raise the price of gold. Things will have to be in an equilibrium and that tells you the ideal price of gold for that point in time.

 

[panduranghari]

We are moving from a currency paradigm where fiat currency is acting as a unit of account (UOA), medium of exchange (MOE) and Store of value (SOV) to

Fiat currency acting as a UOA and MOE but gold acting as a SOV.

This will end the American dream for many Indians and the poor people of the world.

The world will be a better place when the Triffins Dilemma is resolved.

 

[ejazr]

Gold: dulling India’s economy | beyondbrics | News and views on emerging markets from the Financial Times – FT.com

Are India's weddings destroying its economy?

Well, not quite. But the huge importance of gold in Indian culture – especially between October and January, when festival season turns into wedding season – is putting a heavy burden on its troubled economy, according to a report ominously titled "India's Fatal Attraction".

Indians own gold worth nearly $1tn according to the report by Macquarie, the Australian investment bank, and that exacerbates many problems, widening the country's current account deficit, weakening the rupee and generally keeping money that could flow into the economy locked up in cupboards and jewellery boxes.

The $950bn worth of gold held by Indian households is the equivalent of 50 per cent of the country's nominal GDP in dollar terms. All those gorgeous necklaces and other extravagances weigh 18,000 tonnes, or 11 per cent of the world's stock, according to the report.

India imports 92 per cent of its gold, making it the third largest of its merchandise imports behind crude oil and capital goods. Gold made up 9.6 per cent of imports so far for the year ending March 2012 – significantly expanding the current account deficit.

From the report (Macquarie's emphasis):

The rise in gold imports (in value terms) to meet this increased demand is making the country more vulnerable to rising trade and current account deficits. In fact, we think the purchase of gold is resulting in imprudent use of foreign exchange earnings. Net gold imports (gross gold imports less gold jewellery exports) stood at US$23bn (1.3% of GDP) as of FY11. Adjusting India's US$44bn (2.6% of GDP as of FY11) current account deficit with net gold imports, the overall deficit would reduce by almost half to US$21bn (1.2% of GDP).

While India's current account balance would still remain in deficit, it would reduce dependence on overall capital flows to fund the rising deficit and thus make currency less vulnerable. Our estimates suggest that net gold imports alone have contributed nearly 40bps to the 130bps widening in India's current account deficit between FY08 and FY11 (from 1.3% to 2.6% of GDP).

The rupee has depreciated over 18 per cent since August, making it the worst-performing of all Asian currencies. At the same time, India remains alone among its Asian peers in registering a current account deficit.

Despite gold prices rising 64 per cent in rupee terms between January 2010 and September 2011, gold consumption in India has remained relatively robust in volume terms, up 5 per cent year-on-year up to September 2011, according to Macquarie.

Demand in volume terms fell 23 per cent year on year in the quarter ending in September, due to a weakened rupee and during a less traditionally gold-buying period of the year. But because of high prices in value terms demand was up 6.8 per cent. Asia's third-largest economy remains the world's largest consumer of the precious metal.

The rise in gold prices by 500 per cent in the last ten years has increased the wealth of many households, the report says. But because Indians tend not to sell their gold, preferring to pass it down as inheritance, the roughly 8 per cent of Indian savings held in gold remains locked away from the wider economy.

"India has been accumulating gold [for ages] and more than investment it's obviously considered a symbol of wealth, and generally people pass it from generation to generation and prefer not to sell it," Reena Walia, commodities analyst at Angel Broking, told beyondbrics.

Gold is a good hedge against high inflation – which has hovered near double digits for months – but only if you're willing to sell it at some point.

"But today people have realised that there is also value [in gold] as an investment," Walia added, giving the example of Gold exchange traded funds as one way in which Indians were diversifying their gold-buying habits.

The weak rupee, combined with gold prices that hit a record Rs29,912 (around $580) for 10 grams on November 15, has dampened demand, even during the festive season.

Still, over 70 per cent of Indian consumption remains in jewellery, and the stigma associated with a, shall we say, more austere wedding remains strong, among both the upper and lower classes – so the odds are Indian weddings will continue to wreak havoc on the economy for some time to come.

 

[Mad Indian]

Ya , if the govt is incompetant in providing growth and curtailing Inflation, blame it on the society for buying what they want .. This reminds me of other day when a bureaucrat was blaming the Traffic mess in Chennai on the rich and middle class, saying they are having too many vehicles instead of using the Public transport. If the Public transport is good enough , who is going to buy the private transport anyway- cover the incompetance with accusations.

 

[Armand2REP]

There is excellent public transport here, doesn't mean I am not going to own a vehicle.

 

[ejazr]

@MadIndian

The article is by Financial Times based in the UK quoting a Macquarie Bank report which is based in Australia. How did the GoI get involved in this? You should really read the article through before making comments and comprehend what is being said.

Gold and Oil are our biggest import costs. While Oil is a necessity because of the nature of the commodity and contributes the economy as it is consumed, we could certainly do with less Gold imports in the sense that consumers who just buy and gold and keep in their lockers are driving up the current account deficit. It doesn't add any value to the economy as such and is just locked capital that sits away doing nothing.

No other country in the world buys Gold in such large amounts as we do.And remember we are now buying Gold and record high prices. If we have a gold crash, there would serious detrioration in wealth for most people who brought Gold at such high prices.

Instead of allocating our money into Gold at such a large extent, it would have been better if this capital was allocated in say infrastructure bonds or stocks or other investments in the Indian economy.

What the GoI should be doing is taming the demand in the Gold sector by various means as well as maybe launching some sort of education campaigns on the necessity for people to diversify their holdings. At the same making sure that it doesn't make Gold smuggling profitable either.


Equities may gain if government tames demand for gold - Money Matters - livemint.com

 

[Ray]

So.Gold is destroying India?

I was always against this custom of giving gold during weddings.

Maybe because I could not afford it.