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Dollar, rupee and gold

punjab Updated: Sep 01, 2013 12:30 IST

Gold prices will take time to come down and volatility will be its hallmark, for some time. In a short-sighted response, the finance minister has advised us to refrain from buying the asset and increased the import duty to 10%.

Rising gold prices are a reflection of the fundamental weaknesses in our economy. If containing current account deficit (difference between imports and exports) is the aim, then the government can also ask the auto industry, for instance, to stop selling cars to save on fuel imports.

Why is the FM not considering incentivising exports? If stopping consumption and restricting choice was any way to do business and revive the economy, the US would have emerged out of the 2008 morasses by now.

The value of an asset is the cash flow it produces in its lifetime, discounted to present value. However, gold is different and is lifelong. Its value is high because governments and central banks (led by US Federal Reserve) consider it as some sort of backing for currency. However, the US dollar has lost most of its value against gold over past 50 years. It will not be unfair to say that it's not gold that has gone up but the dollar that's slipped.

The value of dollar per se and the Indian rupee vis-à-vis the dollar determine gold prices. The relationship is inverse, with a weaker dollar raising prices and a weaker rupee against the dollar also increasing the price we have to pay. The relationship also works when reversed, in a much more complex manner.

Gold is also defined as a hedge against inflation. When real interest rate is down and close to inflation, it is likely to appreciate in value because to hold the asset (which does not give any cash flow) the investor has to forego interest on other investments.

Till the US Fed continues to print money, the dollar will remain weak. As the printing will continue, till the global economy remains weak, the dollar will continue to weaken. As long as the dollar seems edgy, Asian Central Banks like China, India etc will shift from dollar-denominated securities to gold. Uncertainty makes people buy gold.

Indian gold prices might underperform global markets with increase from current Rs 2,900 per gram to around Rs 5,000 per gram by Diwali 2016. There will be big moves mind you, as much as 5% during a week. Then, it may enter a prolonged bear market.

If international gold prices move up, dollar will come down and gold in India will witness some gains.However, if prices fall in international markets, prompting the dollar to move up, then significant correction is not reflected in our gold because of depreciation of rupee. Rupee fall and strengthening of crude prices globally, given the unrest in West Asia, will impinge on prices. Investment options like the Gold ETFs, gold accounts etc can be considered.

My advice to tricity: do not try to time your gold purchase, even traders have tried and failed. Buy your need and refrain from speculation.