Turning point

If rising prices of onions can effect a change in government, so may fall in value of gold

By Mohan Sule
For every country, company and investor there comes an inflection point that presses for a change in course. For the global economy, growth triumphed over fiscal discipline after the September 2008 credit crunch. No country wanted to experience the Great Depression in the US of the 1930s that resulted from spending cuts to balance the budget or Japan’s lost two decades due to the timidity of the government in stimulating the economy after the property bust of the early 1990s. Despite allowing prominent companies such as Enron, WorldCom and Long Term Capital Management to go bankrupt, a fiscally conservative government in the US enforced mergers and bailed out large banks by using tax money so as not to clog money supply. A socialist government in India realised the importance of private sector investment after it had to ship 67 tonnes of gold to banks in Europe in exchange for US$600 million as reserves had dwindled to finance only three weeks of imports. Prospect of downgrade of credit rating to junk prompted the UPA II government, which had turned the country into a welfare state, to turn attention to controlling fiscal deficit by paring subsidies on fuel and take up pending reforms. The role of auditors, independent directors and pledged shares came into focus in the Indian market after the accounting scandal at Satyam Computer Services. The 2-G spectrum scam showed that a closed and highly regulated industry was not essential to spawn crony capitalism and corruption. IT companies are realising that quality of earning is more important than market share.

It took a while for infrastructure investors to confront the reality that opening up only part of the value chain is meaningless unless supply of raw materials and last-mile connectivity too is freed from pricing controls. After the crash in real estate prices at the beginning of this century and in stocks in the third quarter of the last decade, the lesson for retail investors is there is no escaping from the cycles of boom and burst. The latest correction in commodities supports the belief that there is no permanency in any investment theme. If equities can nosedive or surge, reacting to external or internal factors, so can the value of debt instruments in relation to interest rates, which are not static. Higher is the coupon, more are the chance of default of principal. Till the recent sharp fall in prices, gold had achieved a special all-weather status. A bull run or a bearish phase did not dim its luster: However, the change in its characteristic to an investment option from a hedge against inflation, particularly in the last four years of economic uncertainty, has contributed to gold’s volatility. The launch of dedicated mutual funds and exchange-traded funds has proved to be a double-edged sword. If more inflows have translated into higher returns, they have also exposed the commodity to abrupt outflows.

World over investors take exposure to stocks and bonds to build a safety nest or to make money from trading. In contrast, Indians primarily buy gold for use or as liquidity of last resort. This is because of the agrarian tilt of the economy and inadequate penetration of financial products. Restricted inflows till 1992 and stunted economic growth due to absence of reforms resulted in weak linkages between local and international prices. Even if prices did not spurt sharply, the demand-supply imbalance insulated buyers from steep dips, burnishing the metal’s property as a safe haven. Easy imports have resulted in better availability, meeting one of the criteria for the change in policy, but have not diminished the attraction, the other important objective. Instead domestic prices have aligned to the futures markets in Chicago, with the influence of dollar movements on prices increasing. The turn of events is best illustrated by the fact that a weak rupee now gets a lift from fall in gold prices as the current account deficit narrows. During his term as finance minister, Manmohan Singh had famously declared that he does not lose sleep over stock market fluctuations. Wiser  about the importance of a healthy capital market to boost economic growth during his tenure as prime minister, he is not likely to repeat the mistake. Our policymakers’ agitation over inflation can be traced back to the time Indira Gandhi ousted the ruling Janata Party government in 1980 by harping on the spiraling prices of onions. Now, it will be interesting to see how the erosion in gold holdings of millions of Indians affects the national mood. The war with China in 1962 and the mortgage of the country’s precious asset in 1991 have been two low points for every Indian. Though end March 2013 forex reserves could meet about seven months of imports, we still have to attain closure for the defeat in Aksai Chin. The fall in value of gold might be good for the economy but will it be for those for whom it was the last investment standing?