Gold Glitters- The understanding of Precious Metal
From the desk of Chief Marketing Officer
From the desk of Chief Marketing Officer
Before 2009, I have never analyzed gold as an asset class as I was unable to understand how to evaluate an asset which has no underlying value except what people assign to it and which has no future cash inflows.
As per my understanding of analyzing securities:
- An asset can be and should be analyzed if it carries some future cash inflows
- It exposes itself to the price fluctuation in relation to market forces such as demand and supply etc.
- And most importantly, it carries some intrinsic value or book value with it.
For the sake of better understanding let’s take few examples of known asset classes:
(A) Stocks: it carries future inflows in the form of dividends, price fluctuations are there as to forward earning of the company etc. and every stock has some book value as well.
(B) Bonds and debentures: Contain future inflows in the form of interest, fluctuation with respect to interest rates movements and an intrinsic value in the form of maturity proceeds.
Almost every asset class satisfies the entire above-mentioned criterion to make the same analyzed with respect to its market price.
Now the flaming question in front of me is to: How to evaluate an asset class which has no intrinsic value and as well no future inflows, though it is exposed to market risks and fluctuation in prices like any other security.
Critically saying, if gold is trading at Rs. 28500 per 10 gram, this is the price which people have assigned to it as per their perception.
One can argue about finiteness of the gold or somewhat scarcity of it, but that is equally related to any other precious metals also like platinum, and then I started to believe that Gold is “not a metal only rather a religion. It has such value as people assign to it.”
By the time I started working on analyzing Gold as an asset class, I started seeing people knowing the future of the precious metal more than I do. In a way I relate things to the era before financial crisis of 2008.
Before the financial crisis most of the biggies of financial world felt that they have understood how things worked, then the crisis occurred and things changed. The new developments led to many consequences:
First, they imposed heavy losses. Second, they provided a new level of uncertainty to the world of finance and thirdly they called up the need to search for things to provide more safety and certainty in the new uncertain world.
I guess, this search actually led many to look for Gold as an alternative asset class.
Though, I started advising my clients to look for Gold as an alternate asset class by the mid of 2009, so why I am putting negative things about gold?
Merits of Gold:
No doubt that Gold is an ideal investment, it is a hedge against inflation, accepted worldwide and a reliable store of value also.
Unlike currency, it cannot be created out of thin air and the supply of gold is finite.
Moreover, it is tangible and unlike other forms of investments exist only in electronic form, it can be owned with the feeling of ownership.
Finally, Gold seems to be perfect.
But, to remind again, Gold is nothing but a shiny metal and its applications in the real world are less than that of Silver. Except jewellery and electronics very little of its value comes from its actual usefulness.
Therefore, the purpose, usefulness and applications of gold will not be of much help while putting up a price to it or justifying its prevailing market price.
To an extent I believe “that Gold has no financial value other than that which people assign to it, and thus it should not be a part of typical investment plan.
Due to uncertainty introduced by the financial crisis the gold has attracted attention and has doubled in price over roughly the last two years and I have been asked about my view on gold more in those two years than in all the rest put together.
As I started my career as fixed income specialist, so, by nature I am not very fond of riskier asset class such as equity and commodity and perhaps this is why I never had clients asking me about gold and till the time of financial crisis Gold was considered irrelevant as other asset classes were performing well.
As an analyst, I really find it difficult to value a non-income producing asset like Gold.
I can value a security, company or property by adopting the typical financial strategy like P/E ratios, dividend yield and capitalization rates and comparing to the prevailing interest rates and their historic performances etc. and can arrive at an assessment that whether this asset is cheap or dear.
But to the best of my knowledge, there is no analytical way to value an asset that does not produce cash flows. So one can say that all non-income producing assets are only worth what buyers will pay for them.
One can argue that the same is the case with income producing assets as well as their prices also fluctuate but the price fluctuation is only for short term as they are going to produce fresh cash inflows in coming future and it is obvious that eventually their price will move in the direction of that value. They are not required to do so in a particular time frame but that expectation provides a solid base for investing in them.
I believe that no asset can be termed as good or bad without referring to its price and if it is so, how we are going to evaluate that the price of gold is right?
While having conversation with my client, I asked:
How do you feel purchasing Gold @ 24000/- per 10 gram?
He said: great, I would like to invest in there
I asked: would your answer be the same, if it were 26000/-per 10 gram
He Said: yes, but with little caution
I asked: and if it were 29000/- per 10 gram
He Said: not at all.
I asked: so the price of Gold matters?
He Said: of course
I asked: then how can be you so sure that it is fairly priced at 24000/- per 10 gram.
He Said: hmmm…..,
Many research group has quoted about the fact that gold had hit the height of $850/ounce in 1980 and had gained only 2% per year since then and as of now it would have to be at $2400/ounce to merely equal the 1980 price in inflation adjusted returns.(e.g. Reuters, November 29)
Now this is why I do not like making point to point comparisons. In the above example how do we know that the gold was reasonable priced in 1980. For the time being, consider that the gold was overpriced in 1980 then even failed to show much appreciation in the interim period, it could be still overpriced today.
To support my assertion, I would like to take the mid 1999 period when the gold was $250/ounce; it’s been up approx 16% per year for the last decade. In this case the synopsis for the determination of gold prices on the basis of past prices changed drastically.
To conclude, I would like to say that since Gold has worked for hundreds of years, it probably will keep on doing so. It might not do so forever, but what‘s the probability this will be year it stops?. So I wouldn’t bet against it, rather I might recommend a position in the metal. Not because I see gold as wealth creation tool, but rather as a useful contributor to safety through diversification.
Ya, I think Gold is probably more likely to continue as a store of value and therefore one should have a position.
But remember always to watch is this the right price to start with Gold?????