Gold is no longer an attractive investment option

Gold is losing its sheen mainly due to the stiff measures to curb gold imports being put in place by RBI

From a peak of Rs 32,500 per 10g in November 2012, the domestic price of gold has come down to Rs 25,775 currently - a 20.7 per cent fall in just seven months. During the s period, international gold has lost 29.4 per cent in value. The lower fall in domestic prices can be attributed to the rupee's depreciation and increase in import duty. International gold prices peaked at $1,900 per ounce in September 2011, from where it has fallen 35 per cent. Gold has thus, lost its sheen as an investment option.

A large part of this is due to the stiff measures to curb gold imports being put into place by the Reserve Bank of India (RBI). RBI has been battling a rising tide of current account deficit (CAD) and has quite rightly clamped down on import of gold. The fall in CAD to 3.6 per cent of gross domestic product in the last quarter of FY13 will bring some cheer to RBI, but the apex bank is unlikely to change its policy on imports.

India imported approximately 1,000 tonnes of gold in FY13, valued at $55 billion. This is a direct export of capital contributing to the rising CAD. Under the circumstances, RBI had little choice but to clamp down on gold imports. RBI's moves have several repercussions on the outlook for gold.

First, banks have been banned from importing gold on a consignment basis. This means banks can no longer use their balance sheets to hold gold inventory. This will limit the supply and, thereby, availability of gold in the market. Hence, in a volatile movement of prices, the quantum of sales will not change much.

Second, according to RBI's fiat, bank credit/ gold loan will not be available to the domestic bullion industry. Most bullion industry players used to import gold using their bank credit lines. With this option now not being available, all gold procurement will be 100 per cent backed by cash. This has already had the impact of shrinking the demand size from these players.

The third reason gold has lost its sheen is the increase in import duties. Currently, the total taxes on gold work out to about 9.24 per cent. In a scenario where international prices seem to be falling, these taxes make gold an unattractive investment option.

The other reasons why gold is losing its sheen are more structural. Gold is essentially used as a hedge against inflation. When the real interest rate - inflation adjusted interest rate - is negative, people tend to buy gold rather than invest in bank fixed deposits. This had been the case for the last few years. But with wholesale price inflation now falling to five per cent, real interest rates have turned positive and demand for gold will fall automatically.

Finally, with the continued improvement in the US economy, there will be selling pressure on gold with the exchange traded funds reducing their exposure. This selling will push gold prices down further, making it an unattractive investment option in the short/medium term.

The author is president & chief executive officer of commodities business, Edelweiss Financial Services Ltd