An investment of Rs 100 in gold in 2001 would be worth Rs 460 today. The same amount invested in equities would be worth Rs 450, and in government securities Rs 296. Given the inherent safety which gold provides in times of crisis, these returns are far better than one would have expected. The unprecedented gold prices that we are seeing have been driven largely by investment demand over and above the real consumption demand for jewellery. The world demand in gold for jewellery in the last decade has fallen from 2,100 tonnes to 1,900 tonnes per year – India accounts for 200 tonnes and is by far the single largest consumer of gold in volume terms. However, in absolute terms the world demand has risen from $20 billion to $80 billion.
The bulk of identifiable investable interest has materialised in ETFs (exchange traded funds), which have remained robust even when prices have eased, implying strong longer-term interest in gold. Investment demand has grown from 203 tonnes to 550 tonnes in the last five years, our estimate of current world ETF holdings being at $100 billion. This has been largely driven by the crisis we saw in 2008 and the subsequent flight to safety, followed by extremely easy monetary policies the world over leading to falling yields and few investment opportunities. Concerns over a double dip, or even the shape of the economic recovery, following the onset of the Greek debt crisis has seen resurgence in demand for gold in all forms of exposure. Gold has therefore become an attractive investment asset class.
The supply side, however, has not grown commensurately. In spite of significantly higher prices, world gold production has gone from 3,938 tonnes to 4,070 tonnes. Mine production has increased slightly during the same period from 2,445 tonnes to 2,530 tonnes, as higher prices allowed producers to exploit operations that were not financially viable previously and prolong mine life.
Due to the lack of returns and flight to safety in the western world coupled with the quantitative easing US, Europe and Japan have implemented, investors will continue to remain risk averse. This should support gold prices in the next few quarters. At the same time, any short-term pull back in prices that could occur due to changes in the monetary policy conditions should see increased consumption demand for jewellery from India and China, acting as a buffer for prices on the way down.
We expect the easy money policy to continue for the next few quarters and therefore remain bullish on gold for that period. However, we could see a sharp correction once we go back to a tighter monetary regime that could alter investment patterns across asset classes.
The author is President, Edelweiss Capital
