All that glitters

SMARTSHARE

In physical terms, gold is among the least useful metals. It does have a few interesting properties; it's very ductile and it's almost chemically inert. But apart from arcane lab experiments, the major physical use is ornamentation.

The value of the yellow metal has always been tied to the fact that people like looking at it. Perhaps uniquely among physical assets, it is better to treat it totally as a financial asset. Gold has been the default global currency for millennia.

Until relatively recently, most currencies were backed by gold (the Mughals used silver, and some countries used combinations of silver and gold). But most currencies were benchmarked to gold and that made forex conversions easy. What's more, gold standards ensured that governments couldn't simply print money as they pleased since every note had to be backed by metallic reserves.

The dollar moved off the gold standard in 1973. The Nixon administration realised that it could no longer afford to implicitly offer redemption of outstanding petro-dollars and euro-dollars against metal. In practice, the world effectively moved off the gold standard along with the dollar. But central banks continue to hold huge reserves in gold.

Gold has always been a great hedge against inflation. It holds value and outperforms other assets during inflationary cycles. The flip side is that it doesn't earn a return while nestled in the vault or on feminine cleavage. It is strictly a play for capital gains in inflationary environments.

Global inflationary-deflationary cycles tend to be long. Gold did well through the 1970s and 1980s while oil prices rose. It produced terrible returns through most of the 1990s, when global inflation was low. In the past 3-4 years, it has outperformed most other assets. The oil spikes of the past 18 months have forced prices up to 20-year highs.

The Indian context is interesting. India is among the world's largest gold consumers. Stupid government policies led to rampant smuggling through 1970-93 when India had strict import controls and exorbitant customs duties.

Once those controls were removed and duties rationalised, Indian gold prices have fluctuated in line with global movements. India's privately-owned gold "reserves" are perhaps, the biggest in the world.

Schemes to attract some of that gold into official reserves haven't taken off. The gold deposit scheme involves melting down jewellery and parking it with a bank. That's cumbersome "" especially if the gold in question hasn't paid duty.

It's possible to speculate quite easily on gold contracts on the new commodity futures exchanges. You don't need to block huge sums; you don't need to hold physical quantities and you can dispose of the asset or take delivery with a mouse-click.

Gold exchange-traded funds (Gold ETFs) are also in the offing. These would further reduce entry-barriers for gold bugs. In an ETF, physical delivery isn't available but the base unit may be a tenth of 1 gram, costing as little as Rs 75-80.

Is there a case for holding the metal given that it's already at 20-year-highs? Well, global inflationary cycles do tend to be quite long and oil prices aren't coming down.

Right now, the stockmarket's booming and so is real estate. Both those avenues offer yields as well as capital gains versus gold, which only offers capital gains. But if there's a hiccup on either the housing front or in the stockmarket, gold could be a tremendous hedge.