Saturday, October 30, 2010

Talking about Gold and Silver - Part 1

Even the very mention of the word Gold brings a glitter to the eye, and an eager anticipation of what is to come. Let's face it – there are very few of us who are immune to the magic of gold. It is a source of prestige; a means to outline social standing and wealth; an adornment that is universally desired; a metal that does not corrode easily; something (along with silver) that is considered pure; the ideal wedding gift across cultures; a store of value that protects against inflation, compact and easy to transport, store, and hide; part of the treasure of kings and temples; it is something that has been coveted over the years across the world.

Gold is the universal currency.

There is not much of it in the world. All the gold in the world ever mined could, if melted into one large block fit into a cube of less than 100m x 100m x 100m.  There is only about 170,000 tons of it outside the ground.  

The world has experimented with various forms of currency.  At one time it had settled on the gold standard. Post World War II, in 1944, all countries agreed in the Bretton Woods Conference to be governed by a Gold Standard – i.e. fix the exchange rate of their currencies with reference to gold.  All currencies were quoted in dollars, and the dollar was quoted in terms of gold. A currency note was in effect what a Gold ETF unit is today – a promissory note backed by gold bullion. The US realized before everyone else that this severely restricted the power of Governments to print money as they wished and unilaterally withdrew from the agreement in 1971. The agreement broke down and the others followed suit. Can you imagine how Quantitative Easing will work if the gold standard were to be still in force?

 Currencies are no longer backed by gold, or for that matter, by anything. What holds up a currency is just faith in it and the fact that everyone accepts it. The moment that faith is called to question, any currency could collapse. And Governments across the world are doing all that is in their power to make us call to question the very value of the currency that they uphold!

 Gold is a "real" asset that will hold its value irrespective of what happens to the underlying currency; it is certain to hold its own against inflation; and in case of the ultimate doomsday scenarios, act as the ultimate fallback. When Iraq invaded Kuwait, stock markets were shut, the currency itself became worthless overnight, and people were fleeing across the border with whatever they could salvage. At such times, having a bit of gold helps!  Even assuming such possibilities are for us too bizarre to contemplate, we should still hold some gold as a fallback against severe inflation, and situations in which other assets are unsalable.

 So there is a great personal justification for Gold. There is also a good macro-economic justification for it in terms of having it as "the last recourse".

Silver is a similar story. Except for the fact that it is a lot cheaper per gram, making it more voluminous to store, rupee for rupee.

 

What about looking at gold and silver purely as an investment and seeing how it has performed over the years?

Over the last 10 years the yearly return on gold has varied (compared to the previous year's average price) from  a negative 3% (2001) to 36% (2006) and 23% (2010). CAGR return for the last ten years from 2000 to 2010 is about 16%. The 50 year CAGR growth from 1960 is 7.3%.

Silver presents a similar picture. The yearly returns in the last ten years have varied minus 12% to 58%. This year, compared to last year, we have seen a 27% increase, but last year's prices were about 3% lower than 2008. In the last five years the return has been 14% while the 50 year CAGR is 6.2%.

(All the above figures are based on dollar price data from www.kitco.com )

Indian gold and silver prices, as elsewhere in the world, tend to track the international prices very closely. However, that does not mean that it rises or falls in sync with international prices – the rupee dollar exchange rate comes into play.  Yesterday's (29 October, 2010) price was USD 1359.8 per ounce in New York. The current exchange rate is 44.4 rupees to the dollar. Roughly 31.1 grams is equal to one ounce. Converting the price to Rupees- 1359.8/31.1*44.4 -  gives us Rs.1941.32 per gram while the quoted price is Rs.1940.94 per gram. (Data from www.indiangoldrates.com).

When the rupee/dollar exchange rate is taken into account to convert the prices to rupees, the picture becomes a little more interesting. It shows a 50-year CAGR of 12.2% for gold, and 11.1% for silver. The CAGR for the last five years is above 14% per annum for both gold and silver.

What this tells us is that though gold and silver may fluctuate quite erratically, in the long term they do return significantly higher than inflation.  A 50 year CAGR of 6 to 7 percent in dollar terms and 11 to 12 percent in rupee terms is very good.

The detailed data and workings for arriving at the above conclusions are given in the Annexure. 

More to come on Gold and Silver later.

 

 Annexure

 

GOLD PRICE ANALYSIS

year

usd price

yoy cagr

10yr cagr

50yr cagr

inr/usd

inr price

10yr cagr

50yr cagr

1960

35.27

 

 

 

4.7619

167.9522

 

 

1965

35.12

-0.1%

 

 

 

 

 

 

1970

35.94

0.5%

0.2%

 

7.5

269.55

4.8%

 

1975

161.02

35.0%

 

 

 

 

 

 

1980

612.56

30.6%

32.8%

 

7.8629

4816.498

33.4%

 

1985

317.26

-12.3%

 

 

 

 

 

 

1990

383.51

3.9%

-4.6%

 

17.505

6713.343

3.4%

 

1995

384.17

0.0%

 

 

 

 

 

 

2000

279.11

-6.2%

-3.1%

 

44.94

12543.2

6.5%

 

2005

444.74

9.8%

 

 

 

 

 

 

2010

1194.28

21.8%

15.6%

7.3%

44.4

53026.03

15.5%

12.2%

 

 

 

SILVER PRICE ANALYSIS

year

usd price

yoy cagr

10yr cagr

50yr cagr

inr/usd

inr price

10yr cagr

50yr cagr

1960

0.914

 

 

 

4.7619

4.352377

 

 

1965

1.293

7.2%

 

 

 

 

 

 

1970

1.635

4.8%

6.0%

 

7.5

12.2625

10.9%

 

1975

4.085

20.1%

 

 

 

 

 

 

1980

16.393

32.0%

25.9%

 

7.8629

128.8965

26.5%

 

1985

5.888

-18.5%

 

 

 

 

 

 

1990

4.068

-7.1%

-13.0%

 

17.505

71.21034

-5.8%

 

1995

5.148

4.8%

 

 

 

 

 

 

2000

4.9506

-0.8%

2.0%

 

44.94

222.48

12.1%

 

2005

11.5452

18.5%

 

 

 

 

 

 

2010

18.6121

10.0%

14.2%

6.2%

44.4

826.3772

14.0%

11.1%

 

8 comments:

Aseem Madan said...

Let's go back another 50 years from 1960, and gold CAGR would be somewhere around 30 bps...

All the money the hedge funds have made betting on gold is during the past 5 years, and before that during the California gold rush....besides that nobody has actually made money on gold, it is just good inflation hedge/acts has a diversification play!

FYI!
Besides that Goldman Sachs Analyst has predicted gold price to hit $1650/oz in next 1 year, but the same BREED of analyst had also predicted Oil prices to hit $200/bb but Oil prices crashed to $38/bb....it is deemed as of the worst prediction of the decade...

Dinesh Gopalan said...

Possible. Kitco.com will give you gold prices for more than 100 years. But in those years (a) inflation may have been lesser (b) currencies may have had more worth than they do today (c) only retail, and not institutional factors would have decided on gold price (d) gold would not have been hyped up so much (e) quantitative easing was not very fashionable or done in such quantities as now.
IN short, the world has changed - maybe even going a couple of decades back is not correct. Question is: what is going to happen to gold going forward?

Raag Vamdatt (Financial Planning Demystified) said...

Hi Dinesh,

The returns in Rupee terms have been good, no doubt. But the question is, would it hold up in the future as well?

With India growing the way it is, and being ahead of all the developed countries, our currency would only be appreciating in the medium to long term.

In that case, I believe gold price in Rupees would either stagnate or rise only marginally... Something to think about!

Dinesh Gopalan said...

if our currency appreciates from current levels our economy is going to be in trouble. currently, our current account deficit is being bridged by fii inflows, keeping the rupee strong - how long do you think that will last?

Anonymous said...

4. US - bankruptcy's/scams ( Insider Trading/Hedge Funds) ,Unemployment etc..weaken dollar, commodities price sluggish

5. Japan - no growth

6. Korea - War

7. China - rising interest rates to slow down the economy and funds flow curb

8. IMF - scared of being run out of money to lend:)

Risk Aversion/Flight to Safety usually leads people to dollar denominate bonds ( T-bills) and Gold ( which also plays a hedge on inflation risk)

Why wouldn't anybody not invest in Gold...it is not wise not to have a 5% to 10% of your money invested in Gold at any given point in time. How you do it , depends - either buy ETFs, Physical Gold ( store value issue but banks provide lockers for nominal fees, or buy gold mining companies stock) but whatever you choose have some of your money parked in Gold...

Good luck investing. If anyone knows of any website that helps to portfolio allocation models and optimization - please let me know.

Joseph said...

Thanks for sharing that analysis. I really think that they're huge industries and can definitely help in a lot of ways.

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buy gold coins said...

Thank you for sharing this article, I can't wait for the second part.

online jewelry store said...

Great analysis, this will be helpful in making my decision.