Banking on gold

Gold has stood the test of time in terms of its purchasing power during known human history.

Gold has stood the test of time in terms of its purchasing power during known human history. War,political unrest,and financial dilemmas have caused people to turn to Gold as value store,so has in recent history occurrence of inflation. As Humans evolved,we started printing money,mostly in papers initially backed by store of precious metal,namely Gold and Silver. The gold backed standard was abolished by the UK in 1931 due to massive capital outflow across the Atlantic.

The gold bullion standard was replaced by the Bretton Woods Systems in which many countries pegged their currency to the US Dollar which in turn was linked to Gold at USD 35 per ounce. The dollar peg to Gold was abolished in 1971 as the US realized that it could not pay back its debt in gold due to insufficient gold reserves. Excess money supply coupled with high inflation due to sky rocketing commodity prices set a stage where gold prices rallied sharply for USD 35 to USD 875 within a the span of a decade.

After a lull of almost two decade Gold started its recent bull run towards the fag end of the last decade when it was trading below USD 300 per ounce. Since then it has gone up five folds to over USD 1400 per Ounce. However in inflation adjusted terms gold at current levels is at about half the value achieved during the bull-run of late 70s when gold acted as tangible value store against high inflation and erosion of real wealth.

According to a latest report by World Gold Council,2010 was an outstanding year for gold,with strong demand reaching a ten year high with annual demand of 3,812.2 tonnes. In value terms,total annual gold demand surged 38 per cent to a record of US150 billion. Demand was up 9 per cent y-o-y,and marginally above the previous peak of 2008 despite a 40 per cent increase in the annual average price level between 2008 and 2010.

Major argument behind the ongoing Bull Run in Gold is based on expectations of accelerating inflation as fallout of the record monetary stimulus being offered. To guard against possible erosion of wealth,Gold is being bought as hedge. To support the premise of accelerated inflation,people are pointing at renewed interest among central banks in gold,all over the world. In 2010 central banks became net buyers of gold for the first time in 21 years,removing a significant source of supply to the market. They are likely to continue purchasing gold as a means of preserving national wealth and promoting greater financial market stability.

The other major factor is the strong demand from Asian consumers. The revival of the Indian market and strong momentum in Chinese gold demand together constituted 51 per cent of total jewellery and investment demand during the year.

While it makes sense for Central banks to diversify their assets by purchasing gold but for individual investors with limited resources,allocating excess capital to Gold is unfeasible as it would entail payment for storage and insurance which would diminish the returns. However some allocation to gold is necessary to hedge the inflationary risk associated with other asset classes. Allocation would vary depending upon individual risk profile with conservative investors having a higher exposure as compared to aggressive investors. One of the most efficient ways to own gold,gaining popularity,is to buy gold backed exchange-traded fund.