For a change, a post on money or rather a money-related post!
If you have been following the financial news, you must be aware that after the stock-market bust last year, we are currently in the midst of a boom. Or to put it in terms that savvy investors understand, we are having a bullish market!
At the same time, you will have noticed that an under-performing asset namely gold, has given stellar returns over the past year and a half.
Now, gold is a commodity , admittedly a valuable commodity. But nonetheless a commodity!
So why the sudden gold rush?
A little bit of history, first! Not so long ago, currencies were backed by the gold reserves stored by the central banks. This was definitely the case with the US dollar. Currency was worthless without the gold reserves to support them. See http://en.wikipedia.org/wiki/Bretton_Woods_system
Over time, this changed especially with the rise of America as an economic and military superpower! The might of the dollar reigned supreme! It was the currency of choice to protect other countries and their denizens from the threat of hyper-inflation. Note the recent decision by the North Korean authorities to depreciate their currency and the resulting demand for US dollars. You will have also noted the USD rising when the Dubai credit default crisis news broke!
That’s what you and I can call a ‘flight to safety’! A flight to safety is just that! An attempt to seek safer havens for your hard-earned money!
If you can relate the two, you will also appreciate why the price of gold has gone through the roof! Gold is the Everyman’s hedge against inflation. But over the past couple of decades the price of gold has not appreciated much. In fact, it has barely kept pace with inflation.
It all has its roots in how governments have decided to deficit finance their economies so that the liquidity crisis caused by the sub-prime mess can be overcome. The huge stimulus required to jump-start the economies and keep them on an even keel has made loose money supply a policy until signs that the all powerful and not invisible hand of the government is no longer required to boost businesses and then it can be ‘business as usual’.
The liquidity crisis has definitely been resolved but where does this excess liquidity go? You have to remember that macro economics is not a precise science. It is more of a checks and balances system; you have to tread a fine line. Excess liquidity can lead to an asset bubble and more significantly a much higher rate of inflation.
Before the crisis burst, if you recall, most central banks were tightening money supply to counter inflation. This exacerbated the liquidity problem and affected smaller businesses badly. Central banks all around the world suddenly had to do a volte-face or an about turn!
The price of gold going up is a counter to the weakness exhibited by the dollar. The flight to gold safety is symptomatic of the prevailing uncertainty surrounding the stock markets.
This excess liquidity, caused by a loose monetary policy (i.e. low interest rates), has to go somewhere. And you and I can see it chortling its way up the stock indices. In fact, this excess liquidity seems to be like a modern day Midas. All it touches turns to gold! Even gold!
So do you need to buy gold? Absolutely not! You can choose to buy Gold ETFs which are exchange traded funds that invest in firms whose business is gold or closely related to gold. There is a +ve correlation between how their stocks perform and the price of gold. You could even say that it is a windfall for their stocks.
Or you could invest in index funds that monitor the price of gold. These stocks mirror the market price of gold and are a more accurate indicator of its current market value.
In fact, in India, where gold is traditionally valued, the buying of physical gold has hit an all-time low. Gold is unaffordable to its traditional customers.
So, yes, you could say, for now, that all that glitters IS gold!