Why The Gold Rush?

Gold prices are all fired up, close to Rs.62000 for 10gms for 24 ct (99.9% purity ) gold. Five years back in 2018 the price of gold was close to 31500 and has almost doubled since then. Indians love gold and this upmove will certainly warm their hearts.

Returns from gold are never ever consistent. It can lay low for very long periods of time and suddenly spring up and move rapidly. Although it is never easy to predict any commodity’s prices, we can highlight some reasons as we see it for the recent flare-up in gold prices.

Gold is considered a safe haven and whenever there is some sort of tension in the world money flocks to it. When Russia attacked Ukraine in 2022, it was expected that because of the uncertainty gold would rally.

Gold did rally, not because of investor demand running towards safe assets but because of the Central Bank demand. (Every country has a central bank, equal to India’s Reserve Bank)

Why do Central Banks buy Gold?

Central Banks are bankers and bookkeepers cum accountants cum consultants to the government. They manage the cash flow and all the income and expenses of the country as a whole. A prudent Central Bank diversifies its assets, for eg, India will have US dollars, Euros, other currencies, Gold and what have you.

Most countries as they become prosperous, typically park their surplus primarily in US Dollars. The higher the Foreign Exchange Reserves, the stronger its financial position. Right now India is in a comfortable position as we have over 500 billion dollars in foreign currency reserves. This reserve is used to pay for our imports and other things which we need from other countries, the most important one being oil for us.

In 2022 Russia had over 600 billion dollars in foreign exchange reserves parked in US banks called Nostro Accounts.

And then, It attacked Ukraine.

As a response, the US and EU decided to penalise Russia for attacking Ukraine by imposing sanctions,did the unthinkable.

They froze Russia’s bank accounts and effectively locked them out of their own money. They also kicked Russia out of the SWIFT messaging network, the interbank payment system used by countries to settle international transactions.

The freezing of bank accounts made countries sit up and think and take note. Most countries have their reserves in USD lying in US banks.  If the US could do it to Russia even if was seemingly justified, they could do it to them if they crossed the US or EU for some reason.

According to World Gold Council, the Central banks of China, Turkey, the Middle East, Singapore, and even India bought  1135 tonnes of bullion in 2022, up from 450 tonnes in 2021, and the highest purchases on record as evident from the chart below.

Typically Central Banks buy Gold, they don’t buy it to make a quick buck, they hoard it. So the price has just zoomed up with the rise in demand.

Russia having been locked out of its USD Accounts, could use its 110 billion dollars, worth of gold to keep afloat. A very good reason for other countries to buy and hoard gold for black swan events.

Recently Uday Kotak, a senior respected banker in India called the USD, a “financial terrorist “ for the power it wields as a reserve currency. He retracted the statement but we get the drift. There is a need for an alternative currency with the world’s increasing trust deficit in the USA. To break the ironclad grip that the USD has over international transactions, Dedollarisation is a term that is gaining popularity. It may not happen in our lifetime but it can happen. Before the USD, up until 1920, it was the British Pound for over 100 years that reigned as the king.

But with the fall of British colonies, and the first world war, Britain became weaker and America’s powerful ascent made the dollar the supreme. So we may not see the dollar losing its kingpin status anytime soon but maybe the next generation will. Who knows it could be the INR 🙂  If we played our cards right.

Circling back to Gold,

Central Banks are big buyers.

The US banking crisis which we covered in our Silicon Valley Bank Post and fears of contagion also make people turn to gold for safety’s sake.

The money printing which central banks indulged in post the 2008 crisis has resulted in runaway inflation and reduced value of their currency.

If for some reason the war escalates or the world ends up in a recession,  momentum in gold may pick up in gold. Investors can turn to alternatives like gold and crypto, and the rally may sustain. Or it may just fizzle out. You can never tell.

We also need to put out there that there is a belief that if interest rates rise and risk-free assets like government securities give good returns ( our 10-year Gsec is @ a 7% yield currently, US 10 years @ 3.6%), gold prices tank.

Why?

Gold is not an income-earning asset as compared to Government Securities, so investors prefer to invest in Gsecs. Unless there are other compelling reasons like diversification and planning for an implausible eventuality like the US acting like a big bully and imposing sanctions.

So it is hard to tell if gold will rally will sustain or not, it should always find a place in your portfolio as a hedge and a stabiliser.

If you wish to invest in gold we have covered ways to invest in gold in our earlier post.

Keep in mind that Gold Mutual funds have lost their earlier tax sops. Investors of Gold mfs and ETfs will have to pay short-term capital gains no matter the period of holding.  As things stand now, for long-term investors in gold, in our opinion, Sovereign gold bonds have the most favourable terms as they carry a small coupon, and capital gains are free if held till maturity.