India's Gold Rush - Part II

Recently, there were a lot of measures from the government both direct (import duty on gold) and persuasive (public awareness & messages) to discourage investors from locking up their savings in gold. So, it makes you wonder why the government is advising against your purchase of gold. The primary reason is to reduce our current account deficit (CAD) to managable levels.

Why is it advantageous to have a lower CAD? 
Having a lower CAD offers the same advantages as having a lower debt in the case of an individual. The amount of money locked up in buying gold could be used to import other valuable and productive commodities much needed for the economy.

• Lower CAD helps in stabilizing the Indian Rupee and assists in managing import costs
• This in turn could bring down inflation and benefit those that save 30% of their earnings to get better real returns on their savings
• A lower debt provides India with an ability to borrow at lower rates, greatly reducing our interest burden/outflows
• The savings in interest outflows could in turn be used to spur the domestic economy and create more employment and better infrastructure
• Sustained lower debt levels could help accumulate forex reserves, which could be used to make overseas investments in say energy sector. This could help bring down our dependence on oil imports in the long run (China spends over 30bn investing in energy companies, while India spends only 2bn in a year, although energy needs are the same)
• Overseas energy investments could in turn bring down the import cost of fuel for our future generations and there by reduce inflation
• At a broader scale, lower debt provides better economic and political strength when negotiating commerce and trade dealings with western powers

What measures have been taken by the government to curb gold imports?

• The government has raised import duties on gold twice since Jan. 1, 2013 doubling it to 8 per cent (this did not have much impact on our import volumes)
• The central bank moved to tackle supply, such as making jewellers pay for gold up front, this has produced more impact
• Recently (27 Jun 2013), RBI also disallowed using credit of any form to import gold (expected to have significant impact on gold import)
• More measures such as producing PAN card to buy gold at lower ceiling are being considered (presently PAN card is required for purchases above Rs.5 Lacs)

Whether the measures are adequate in curbing the unsustainable gold import levels in the long-term remains to be seen. No matter what measures are taken by the government, the only factor that can really bring about a change to this situation is the individual buying gold. The average indian needs to question himself/herself whether in modern living does it still make sense to measure one's financial success by the quantity of gold possessed?

Is gold really a hedge against inflation?
To answer this question, it helps to compare the CPI (Consumer Price Index) of India with Gold prices(US$) over a 20-25 year investment horizon. CPI includes a basket of goods that a typical household would need to buy every month, year after year. The annual percentage change in a CPI is used as a measure of inflation.

Year    CPI-India    %Rise-over-1990    Gold Px/oz    %Return-since-1990
1990    40                 -                               $400               -
2000    100              150.00%                   $300               -25.00%
2006    120              200.00%                   $600               50.00%
2012    200              400.00%                   $1600             300.00%
2013    226              465.00%                   $1200             200.00%

Even if we take the peak price of $1800 in 2011, its return is only 350%, much lower than the 400% rise in CPI in 2012 and 465% rise in CPI as of date. On an annualized basis, rise in CPI is 7.8% p.a while return from gold is 4.8% p.a over the last 23 years. This brings up the question whether returns from investing in gold has kept up with the percentage rise in India's CPI basket of goods. The data implies that gold may not be an effective hedge against inflation.

So, this leaves you wondering if you should shun gold altogether? Or should it still be a part of your portfolio of assets..