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What Are You Lusting For, A Commodity?

Gone are the days when the yellow metal could hedge you against inflation or bad times

What Are You Lusting For, A Commodity?
  • Gold price touches 18 1/2 year low. —Newspaper headline, January 12, 1998
  • Gold may go down another 10-15 per cent. — Mark Faber, known as Dr Doom, a Hong Kong-based investment consultant
  • The question for 1998 is not if the price will rebound, but when it will rebound. — Williams de Broe, member, London Stock Exchange
  • Buy...buy...buy...! — Huge queues outside Indian gold shops

    IT started on August 15, 1971. As India was celebrating its 24th Independence Day, on the other side of the globe, US president Richard Nixon was changing the rules of the global economy. Faced with a massive negative trade balance and a high unemployment rate, Nixon, sweating visibly, announced that he was taking the US dollar off the gold standard. No longer was the value of a currency dependent upon the country's gold reserves.

    Within two years of Nixon's historic step, most other countries had followed suit, floating their currencies. India too. Meaning, the value of the Indian rupee was judged against a basket of currencies, and not on the tonnage of gold held by the RBI.

    The Death of Mystique: The price of gold should ideally have crashed right then. That it has taken more than two-and-a-half decades to fall is actually amazing. In the sub-continent, the issue is more serious than money: it involves sentiments. The mangalsutra is of gold, every housewife measures her net worth in gold. Pawning gold bangles, and the accompanying emotional upheavals have been the pivot-point of Indian commercial cinema. Even as you read these lines, thousands in Chennai are celebrating Pongal by buying gold; up north, the marriage season is in heat; all over, a child is born; the gold rush is on.

    "Gold has been associated with our civilisation since time immemorial," said commerce secretary P.P. Prabhu, last August, at a conference organised by the World Gold Council. "And notwithstanding all import restrictions, we seem to have accumulated high stocks of gold over the centuries." India, however, is not alone in restricting gold trade. According to Bannock Consulting's An Overview of Regulatory Barriers to the World Gold Trade , there are only two genuinely free gold markets in the world: Dubai and Hong Kong.

    India banned the import of gold in 1947. In 1963, the Gold Control Act was introduced, which put limits on gold holdings,and licensed all gold transactions. This drove the industry underground, and by putting the clause that all dealers needed to operate from one location only, fragmented it. As a result, there are 23 lakh small dealers operating in the country today, and no large players, no wide distribution.

    As a result, Indians generally pay about 10-15 per cent higher price for the gold they buy—the unofficial hawala premium has to be factored in—an excess that adds up to Rs 4,000 crore every year. With prices falling, the traditional Indian psychological security linked to it is going haywire. A hedge against inflation? Not gold: against a rather low inflation rate of under 5 per cent, the price of 10 grams of gold is currently quoting at Rs 3,985, down 18 per cent over the last year. Adjusted for inflation, the fall is as high as 23 per cent.

    After the stock debacle, the fixed deposit defaults, and falling real estate, the last investment standing? Not gold. Gold is more like a pariah for investors right now.

    Which is what gold analyst Richard M. Plomboy, CEO, Plomboy Capital Corporation, stated in October at an investment conference: "I have found that when I talk about gold, some people walk out, some take out their newspapers, others wonder what's for lunch.In short, it's not politically correct to have anything good to say about gold." The last 12 months has seen the international price of gold fall by 25 per cent to $287 per ounce.

    Banks Have More Fun: The major reason is that central banks across the planet are planning to sell their gold holdings. Australia hopes to sell 167 tonnes, Latin America is waiting to take the lead, and most important, Switzerland has announced plans of putting its 1,400 tonnes of reserves into the market, for which the country will vote in 1999. There's a formidable 36,000 tonnes of yellow metal that the world's central banks own. If they choose to sell, there wouldn't be much difference between gold and gravel. According to Williams de Broe, member, London Stock Exchange, central bank selling is "clearly the largest worry hanging over the gold market".

    Curiously, banks selling gold has been a regular feature of the bullion bazaar for the last two decades, and on an average, these banks have been putting around 400 tonnes of the yellow metal in the market every year. Two obvious questions arise: one, why is the price of gold plummeting so sharply today, when the central banks have been sellers for 20 years? And, how long and how low before the downtrend peters out?

    The second question first. According to Plomboy, the central banks have sold much of what they want to sell, and sentiment is at its worst—just the right catalyst, for investment demand. And Williams de Broe concludes in a recent report: "We expect the gold price to bounce to the $360-400 range during the first half of 1998."

    Promise to Pay: Behind Plomboy and de Broe is the one most compelling force that should push the price: faltering paper markets. Nixon's greatest contribution to society has been just that: the creation of an entirely different financial system—completely alienating gold. As a result, gold in its historical role as a currency is fundamentally incompatible with the modern worldwide financial system based on a 'Promise to Pay'. Take that Rs 100 note out of your wallet, and look at it closely. Is it Rs 100? No. On it, the RBI governor simply states, "I promise to pay the bearer the sum of one hundred rupees." The promise is not backed by anything material like a gold reserve.

    This currency system depends for its functioning on faith. A faith that this debt that the RBI owes you will be paid someday. Trillions of dollars of such debt is being issued world over. This system was set up because economies grew faster than gold could finance. More money than was available was needed to fuel the financial system, which in turn financed businesses that produced everything from cars to combs and employed millions of people in scores of nations.

    What Gold Really Is: The crucial point is: if gold is not money anymore, then it's just another metal, a commodity. And that's the way you have to look at it. If you yet see gold as another name for money, you'll have to wait for the unlikely scenario when the world returns to the gold standard.

    Or when the gold mines close down, leading to a shortage of the metal. Already, miners are feeling the pinch: their cost of mining gold is higher than its selling price. At stake are hundreds of thousands of jobs in South Africa, Australia and the US—a politically unviable proposition. Will Uncle Sam allow it? Unlikely.

    Whether its price rises—as the gold mining companies through their mouthpiece the World Gold Council would have you believe—or whether it falls—as others are convinced—is only a minor detail. Speculators are picking it up, thinking it's touched its nadir. Smart investors are tracking it closely, just like they follow stocks, bonds and other commodities.But in India, the world's largest gold consumer, economics has no place: you just go to the market and satisfy your lust.

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