A dependable winner - GOLD ETF

A dependable winner
Ever wondered why we say something is ‘as good as gold’? Perhaps it’s because it stays strong even through bad times
Devendra Nevgi

RECENTLY we moved into a new house, which was an uphill task for all of us, taking into account real estate prices these days. While cleaning up the old house, I discovered an envelope in a dilapidated condition, in a corner of a cupboard. I opened it with great curiosity. I found an Rs 1,000 note issued in the 1970s, and around 20 grammes of gold. Had I struck gold in finding the gold, or in the currency note? I wasted no time in seeking out my father and asking him about it. He said he had forgotten all about the gold and the note lying in the cupboard. But now that they had been found, he remembered everything quite clearly. In the 1970s, he had a surplus of Rs 2,000. He bought gold worth Rs 1,000, and left the balance Rs 1,000 in the envelope. Unknowingly, he had taken what in market parlance is called a long position on gold and on the Rs 1,000 note (or rather, the purchasing power of it). I was eager to work out how my father’s “long position” was faring now, after more than a quarter century. In 1970s, a Rs 1,000 note was lot of money. It could have bought my father at least 4,000 samosas (at 25 paise per samosa). My father said, “For Rs 1,000, I could have treated the whole neighbourhood to a sumptuous lunch.” Or he could have bought around five square feet of real estate in Cuffe Parade (at Rs 200 per square foot). Wow, I thought—the good old days! Now back to reality. How many samosas would Rs 1,000 buy today? I made a couple of quick phone calls. The local Udupi restaurant said it would supply 100 samosas for that amount. And our real estate agent, after a few quick sums on his calculator, said Rs 1,000 would buy me an utterly underwhelming 0.025 square feet of property in Cuffe Parade. So the question is, why is the number of samosas less by 40 times, and the square footage in Cuffe Parade less by 200 times? This is what economists call “inflation”—a rise in general price levels. You just cannot buy the same amount of goods for the same amount of money after 25 years, since the paper currency loses its purchasing power. Usually, paper currencies are issued by countries’ central banks, like our Reserve Bank, on behalf of their governments. Central banks are expected to have control over the money supply, and currency is part of it. Theoretically, the money supply can be infinite. As you might expect, anything is in infinite supply loses value over a period of time. Central banks try to ensure, however, that money supply levels are proportionate to economic growth. In the event of a financial crisis, such as the one in the United States, or a geopolitical crisis, such as a war, central banks may print more money to tide over difficulties. Indeed, the US central bank has stopped declaring money supply figures, so they can print any amount of dollars. More money chasing the same amount of goods can lead to inflation. And too much paper currency or inflation leads to the loss of purchasing power. Zimbabwe is a classic example of paper currencies losing purchasing power. The International Monetary Fund recently estimated Zimbabwe’s inflation at 150,000 %! In effect, a Zimbabwean dollar loses value between the time you leave home, and the time you reach the shop to buy a loaf of bread. It’s better to hold real assets in such a situation—like gold. Which brings us back to the contents of that dilapidated envelope I found. What can the 20 grammes of gold my father forgot in the cupboard buy today? At the current prices, we could choose between 2,200 samosas, or at least half a square foot of property in Cuffe Parade. This means the gold fared much better than the Rs 1,000 note. So gold is a hedge against inflation, and limits the losses that would be incurred due to the eroding value of paper currency. Gold also acts as a kind of “insurance”, since it tends to fare well in the face of uncertainties, such as the ongoing global market crisis. During periods when the Sensex has yielded negative returns, gold has given decent returns. If this logic holds through the current uncertainties in the markets, holding gold will help investors stabilise portfolio returns. With the US on the brink of recession, inflation not abating on higher food and commodity prices, and the dollar depreciating, conditions are ripe for gold faring well as an asset class. The uncertainty of the current fragile financial situation will help gold. The most appropriate way to buy gold is to buy a low-cost gold exchange traded fund (ETF), ideally one in which there are no entry loads. Entry loads and higher costs eat into investors’ returns. Acquiring gold through ETFs, as opposed to buying gold itself, eliminates the hassles of storage, security, quality, insurance, transportation, goldsmith’s charges, and so on. Besides, you would have easy liquidity and price transparency, as the fund would be listed on the stock exchange. In 1690, the Massachusetts Bay colony issued the first paper money in the colonies that later became the United States of America. The US dollar as a paper currency was first issued with the inscription “In God we trust”, as required by the US Congress in 1957. The inscription appears on all US currency since 1963. Given the direction the US economy has taken lately, perhaps that should now read “In Gold we trust”.

Devendra Nevgi is CEO and CIO, Quantum Asset Management

Times of India, Mumbai,5th Feb 2008, Page 43