Behind the glitter: Why is gold going up in value, how should you invest?

It is not an interest-bearing asset and has precious little industrial use

The oldest class of assets — precious metals such as gold, silver, and platinum — has been among the better performers of 2024. Gold, in particular, is up 11 per cent since January. It has been hitting record highs and commodity traders expect it to keep going up.

That is 11 per cent, in terms of United States dollar values. In rupee terms, the returns are higher, since the Indian currency has lost ground against the dollar.

Gold is not only one of the oldest known assets; though it is among the more unusual. It is near useless in industrial terms, with the very few applications such as in the decorative industry, unlike silver and platinum, both of which have large industrial footprints.

The physical yellow metal is not an interest-bearing asset either. And yet, gold is a reliable hedge against inflation and uncertainty. Moreover, it is a hard asset — it can be converted into cash easily, or used as collateral for instant loans.

This is why every Indian family (and Chinese, Malaysian, and Korean) likes to hold gold. It is also why central banks such as the Reserve Bank of India and the US Federal Reserve hoard gold, and why inflation-ravaged Zimbabwe is introducing a new gold-backed currency. Gold saved India in mid-1991, when forex reserves had dipped to $600 million — just enough to pay for a fortnight’s imports. India pledged 40 tonnes of gold to tide over the crisis.  

Behind the glitter

Indians are among the world’s most enthusiastic hoarders of gold — households are reckoned to hold more than 21,000 tonnes. It ranks just below oil and gas on the import list, although, as part of an effort to curb imports, the government has introduced several innovative schemes to wean people off the physical metal.

So why is gold going up in value?

There are quite a few answers and they are linked. First, inflation. Covid-19 scrambled global value chains. Then the Ukraine War scrambled them all over again. Shortages and supply disruptions in energy, semi-conductors, pharmaceutical drugs, food, and what-have-you have meant high inflation.  

Not only does the Ukraine War continue, the Israel-Gaza War has now created new tensions. A blockade of the Red Sea by the Houthi, and fears of escalation if Iran gets into the act, have triggered fresh fears of disruption of oil and gas. This could mean another round of inflation.

A second set of uncertainties also arises due to possibilities of multiple regime changes. Around 40 nations, including India and the United States, are due for elections in 2024 (or have already had election, as in the case of India’s neighbours). Those affect 4 billion people, and therefore, investors have to factor in political uncertainty, and inevitably, uncertainty also leads to fresh demand for gold.

Gold is linked to the US dollar, as pointed out earlier. If the US currency goes down, gold prices go up in $ terms. The $ is expected to weaken because the Federal Reserve has signalled it will cut interest rates this year. Some speculators are loading up on gold in anticipation of the cuts.

Supply side

There is very limited new supply. Gold has to be mined and global production is only around 3,100 tonnes of which China produces around 10 per cent.  In 2023, around 4,450 tonnes were traded, and that was 5 per cent lower than in 2022. The Federal Reserve alone holds more than 9,000 tonnes of gold. India imported around 750 tonnes in calendar 2023 at a cost of Rs 2.8 trillion.

Demand therefore exceeds supply, which is one reason gold often beats inflation. Demand has historically exceeded supply except during brief periods, when new supplies have been discovered, such as the colonisation of South Africa, the colonisation of the Americas, the gold rush in California (1849) and The Yukon (1890s). Commodity traders believe this bull-run could last till 2030.

India’s policymakers have a love-hate relationship with gold. On the one hand, the RBI buys gold (it is buying now). But policymakers dislike the fact that private citizens also buy gold. In 1968, the Gold Control Act prohibited jewellers from keeping more than 100 grams of gold in inventory and banned ordinary citizens from holding coins or bars -- they could only keep jewellery.

This Act generated lots of employment for huge gangs of smugglers. It also gave rise to the romantic legend of the Robin Hood smuggler, which inspired many Bollywood megahit movies (think Deewar).

After the Act was repealed, India’s jewellery industry has done a terrific job, deploying creative design and innovative processes to service domestic and global demand. Titan’s Tanishq is the world’s most valuable jewellery brand, for example, and there are many other highly-regarded brands. The industry can also boast of Nirav Modi, who is of course, well-known for being a little too creative in terms of financial engineering.

There is actually plenty of legally sanctioned financial engineering centred on the metal. India’s love affair with gold goes back to deep antiquity and it is unlikely to terminate any time soon, since there are sound reasons beyond tradition to hoard the yellow metal (or its digital equivalent).

Becoming a Gold Bug

Financial Planners often suggest that investors should allocate a small component — say 5 to 10 per cent of their portfolios — to gold. The drawbacks to owning gold used to be bulk, uncertainty about jewellery caratage, fears about physical safety, and the absence of guaranteed return since there was no interest income.

In terms of purity, Titan and other jewellers now offer guarantees and over-the-counter tests of purity. Banks sell certified gold bars as well.  Incidentally, you can buy up to Rs 2 lakh worth of physical gold without furnishing PAN or Aadhaar, etc, in a single transaction. But you have to pay goods and services tax (GST) on a physical transaction. Jewellers will break up a large transaction into several Rs 2 lakh components, so this is a useful and potentially legal route to convert cash into gold.  

The 21st century investor can also take exposure to gold in other ways to avoid the above issues.

Sovereign Gold Bonds (SGBs) offer interest income (2.5 per cent per annum) and favourable tax terms if the SGB is held to maturity (eight years, unless you buy a bond which is close to maturity). This is an electronic instrument. No GST is payable. No storage required. No worries about purity or physical safety.

Another electronic instrument is the gold ETF, of which there are many. A gold ETF holds gold and sells units to investors just like any other ETF. Investors can buy SGBs and ETFs easily.

There is also a whole segment of the NBFC (non-banking finance companies) industry that works on the basis of gold loans. The sophisticated investor can look at buying shares in listed companies such as Manappuram Finance and Muthoot Finance as an indirect exposure to the metal. Banks have also got into the lucrative gold loans business.

In sum, an investor who wants gold exposure now has a plethora of choices, including both the physical, and various electronic instruments.