Wow …… the Finance Minister raises the customs duty on gold from 2 to 4% and reporters hail the move calling it ”reformist”. Gold to them is an unproductive asset!! What a bunch of jokers! The additional levy of 2% tax they feel would ensure Indians would invest in more productive assets such as land, stocks and bonds and bring down the current account deficit (loosely imports less exports)
Let’s begin with some sound financial numbers and not fiscal jugglery as practiced by the finance ministry (FY13 budgeted fuel subsidies to be lower than FY12 fuel subsidies….yeah right).Cost of 10 gms of gold in 2007 was valued at around Rs10,000 approx.The value of 10 gms of gold in 2010 end was around Rs17,000 .Switch over to 2013 10 gms of gold is valued at Rs28,000.
These are numbers which I have tracked and I have purposely refrained from “googling “pre 2007 gold rates.This means that the value of gold has almost tripled from 2005 to 2012/13.Those on the technical side will note that the value has grown at a rate of 18% from 2007 to 2012/13 compounded annually and by 17% from 2010 to 2012/13 compounded annually. Compare this with RBI bonds (those backed by the Government of India ) which gives a coupon rate of interest of around 8% to 8.5% depending on the tenure. Compare it with the PPF rate of return of 8.5% or even better with the EPF (employee provident fund) rate of return of 8.25% (Government of India reduced the rate of interest from 9.5% for 2010-11 to 8.25% for 2011-12).Even if the returns on PPF and EPF are tax free (this might change according to the DTC under the EET – Exempt Exempt Tax model) it is quite clear which asset class gives a better return. Also what stops the Government of India from reducing the EPF rate again?
Imagine the fate of a salaried individual who is forced to contribute 24% of his basic salary (12% employer's contribution and 12% “our “ contribution ……..entire 24% comes under our CTC!!...do not know why they call 12% as “employer's contribution” then !!) See’s his pension fund interest being dictated by a finance official mandarin, being reduced again?
So my EPF interest rate is at 8.25% while the inflation rate is at 10%! This means that the real value of my pension fund kept in the EPF, inflation adjusted has decreased. The 10% inflation that I talk about is certainly on the lower side.I have yet to consider the price hike in fuel which will take place (at the time of writing the Government has shied away from raising the price of crude due to the state election) and the insane increment of service tax and excise duty from 10 to 12%.So given a choice where should one invest…….EPF,PPF,government bonds stocks or GOLD!
As stated earlier, I had almost chocked when some so called educated news reporters called gold an “unproductive asset”.Lets compare gold with land .Yes unlike land we cannot grow crops on gold, but what other advantages does land have over gold? Gold can be traded ,more easily than land; legal documentation of ownership of gold is of higher quality ( imagine investing your life savings in a piece of land or an apartment and then discovering that the land had legal ownership issues).True you cannot live inside gold but you can surely sell your invested gold getting higher returns and then purchase a property.
The comparison with property is an important one .No other asset class in India other than property can match the appreciation in gold over a relatively longish period of time .Property prices remained static (not declining like stocks)even during 2008 -09 during the post Lehman Brothers crisis while gold kept appreciating. Yet it is imperative for social security and peace of mind that we all own “our own “apartment or a dwelling to retire to for the day as well as for life.(read not “owned by the bank “!!).
Lets come to stocks (ha ha the great ponzi scheme) .Equity markets are at a high now.Flush with liquidity from QE and the LTRO stock markets are once again in the headlines.Pray switch back to 2008 and 2009 post Lehman brothers collapse when the stock markets tanked or a few years earlier when the dotcom bubble had burst or just immediately after the Harshad Mehta scam. Getting a better picture? Investing in a stock market is like playing Russian roulette with a nuclear bomb.Let us look at a hypothetical scenario where a retiree who had invested all his money in a Mutual fund with 100% exposure/investments in equities and by some chance had retired in 2009, his 10 lac investment would be worth around 50% of the invested amount or even lower.
So the next time you read an article in the news paper or hear a smart wizkid on television asking you to invest 50% of your savings into equity ( not gold or property) you know it is time to get a better newspaper or change the channel. Now let us make the situation a bit worse for our poor retiree , let us assume that he had saved his retirement funds for his child’s marriage ( likely scenario in the Indian Context) the value of his savings has gone down from 10 lacs to 5 lacs, the price of gold unfortunately has increased and so has the entire cost of getting his child married. What does he do? He has no option but to sell his stocks or redeem his MF units at a loss and sell off any other property that he has.Worse he might have to go in for a loan (unlikely that any banks will lend him any money since he has retired). A nightmarish scenario indeed!
You will often hear analyst say that stock markets over 20 years or a longer period of time will give you better returns that bonds or other saving instrument e.g. PPF,EPF etc (they never compare performance of the stock market with gold prices inflation adjusted).Yes true but what if in the middle of those 20 years you needed money to finance your children’s education or marriage and the stock market went bust exactly during that time period? Postpone your child’s education or marriage?
The only asset class which has kept itself at par with inflation is gold. A while ago the gold standard was in practice. Under the gold standard countries would keep their currencies pegged to the dollar, any movement in the dollar would lead to a proportionate change in the value of their currency ,keeping the peg fixed at all times.The U.S. in turn fixed the price of gold to the dollar.I am not getting into a debate on the benefits or the drawbacks of the gold standard. The gold standard was abandoned under Nixon in 1971 and the world has moved on since then.
The current global economic crisis precipitated by the situation in Greece, Ireland,Portugal and soon to be Spain and Italy (and many more to follow) have lead central banks all over to start printing as if there is no tomorrow .Printing more notes unfortunately will just lead to more inflation in the long run. The value of money as a result will go down. Add the coming crisis in Iran and you will see inflation in its worst form. Your EPF returns will keep giving you 9.5% oops 8.25% but the price of a litre of bottled water would have increased by 10%!
Where should any rational investor then invest? Surely he has to invest in an asset class which gives him a rate of return higher than the inflation rate.No not stock markets (God do we not learn from the stock market crashes) not in EPF,PPF ,Government bonds ( try the Greek Government bonds !!) ,land ( yes if you had that much money),apartments (yes good option if you have the money) or do you invest in an asset class which has trebled in last ten years? Keep in mind that you need to buy your house with your own funds, if you borrow from the bank and the bank interest rates keep rising as they have since 2011 to keep inflation in check your EMI’s will go up sending your already tight budget into a tailspin.(unlike the government we do not have our own mint! ).*EMI’s have fixed interest rate usually in the initial years of the loan before switching over to a floating rate of interest.
In the Indian context it is very important to realize early on in your working life that gold would be a necessity for your children’s marriage. Gold is hence required not only as an investment asset but also to meet social obligations. Unfortunately I do not see a crash in gold prices. (This would provide me with a buying opportunity).Also remember that gold is a commodity and its supply will one day eventually run out.
When that happens we all know where gold prices will be heading to.
Please also ensure that when you in invest in gold you invest in gold in its physical form and not in its paper form.
DTC- Direct Tax Code
PPF- Public Provident Fund( Voluntary saving scheme) Account either in State Bank of India or Bharat Post
EPF-Employee Provident Fund( Compulsory contributory scheme for most salaried employee’s)
QE- Quantitative easing.
10 lacs- 1 Million
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