September 2011

Introduction: Gold has been in the news of late for a number of reasons, including the recent steep rise in prices.

• This metal caused a ‘gold rush’ – the migration in USA from East to unexplored West in the 1800s
• It has been a currency and a store of value for man since centuries.
• In the year 1971 a certain US president freed the US dollar from the Gold standard. Today 40 years on, the USD has fallen considerably in value, and leaders in the US have come full circle, and are mulling a return to this standard.

The main uses of Gold are:

• A store of value. For governments, their currency is backed up by gold
• For individuals – gold is bought in the form of jewellery and gold coins
• Other minor uses like in electronics, computers, dental, idols, etc.
• Investments in Gold – Commodity trading or ETFs

Some Perspectives: The fig 1 graph below shows that Gold has been ignored as a store of value in recent decades.

The key factors that influence the price of Gold today are:

• Financial uncertainties like Currency and Debt problems

1. The US government has taken on too much debt to fund their domestic and international spending. The economy has been downgraded by S&P for this, and the USD is no longer a safe store of value.
2. Unless the US debt situation recovers – unlikely given their monetary policy – gold will continue to be safe haven for governments in their Forex baskets.
3. The European Union is also facing challenges due to economic slowdown and the inability of member countries to control government spending.
4. Under such circumstances, Gold tends to appreciate

• The developed economies of North America, Europe and Japan are not doing very well in 2011, with slow economic growth and high debt plaguing these countries
• Individuals from India & China continue to buy gold. High inflation means that cash is losing value. Higher affluence means more spending in gifts and jewellery. Indian marriages will always need gold, right?

Price Action: Is it any wonder that the value of Gold has appreciated in recent times? See fig 2

The trend, as we can see, is that Gold is appreciating.

The main question is, till when? The answer I feel is linked to the events in the two key developed regions of the global economy.

• USA:  This country is struggling with a weak economy, high government expenditures, and high overall debt. The debt recently hit pre-set limits, and they had to raise the limits for the government to continue normal functioning

1. Until the growth in debt is arrested – by both increased taxes and reduced spending, and the economy starts on the recovery process, Gold will be an important store of value in this, the largest economy with the greatest wealth

• Europe: Iceland, Portugal, Spain and Italy have imbalances in their economies with low growth, high debt and deterioration in assets like real estate

1. Germany and UK are seeing low growth
2. As the common currency is the Euro the countries do not have the flexibility of devaluing their currency to battle internal economic ills
3. There is now a tension in the European Union, and the challenge will be to repay debt and still keep these countries together through these tough times. It may take 1-2 years for the situation to stabilize. Until this happens, Gold will continue to be a safe haven

Projections and Investment advise:

• Gold will appreciate for the next 1-2 years, until the above economic problems at least appear to be receding.
• Gold price rise will gather momentum, till it ends with a sharp rapid peak.
• Investors are advised to invest with a 1-2 year perspective.
• Investments should be in monthly SIP form, and the recommended investment instruments are Gold ETFs, from companies like Kotak, UTI, Reliance, etc. (For more on SIP investing check article)

Risks:

• Gold, unlike stocks is only a store of value. It does not give dividends. The investment in gold is not productively utilized.
• The price of Gold has appreciated rapidly in the recent past. The peak followed by a change of direction can be rapid, and the fall very steep. Investors need to track headlines and prices and make an informed exit call.
• Short term trading in gold has increased substantially, causing volatility in prices. This is an early indication of excessive interest in gold as an asset class

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Disclaimer:

These reports and documents have been prepared by JainMatrix Investments Ltd. They are not to be copied, reused or made available to others without prior permission of JainMatrix Investments. Any questions should be directed to the director of JainMatrix Investments at punit.jain@jainmatrix.com

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