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Why Gold Prices are Rising?

Gold Prices have reached all time high & in near future there is no possibility of drop in Gold Prices, It will increase further…Most of us wonder Why Gold Prices are Rising? Simplest explanation is since Inflation is High and Gold is best Hedge against Inflation therefore Gold is appreciating. Economics calculations are not that simple…Economics is web of complex calculations where each factor is linked to many other & on top of that sentiments are key driver of Economy….In this Post, i will try to explain in simplest possible way “Why Gold Prices are Rising?” despite interventions from Govt to cool off demand…

Yesterday Pranab Dada said that “We need to dissuade people from investing in Gold”. From quite sometime Govt is trying  to discourage people from investing in Gold thus controlling Gold Prices…Govt increased customs duty on Gold Coins and Bars with 99.5% purity from 2% to 4% & on non-standard gold from 5% to 10% in Union Budget. It is known fact that Increase in Customs Duty is basically a step backward towards License Raj which will encourage smuggling of Gold and will give sweeping powers to taxman to harass honest tax payer.

Why Govt is doing this? Reason is very simple that India is largest importer of Gold….In order to import Gold, Govt has to shell out Dollars. Last FY, Govt spent whooping 60 Billion Dollars on Gold Imports…Import of Gold also impact Trade Deficit negatively….Till the time the value of Rupee was in comfortable zone against dollar, it was fine but now Rupee is at all time Low against Dollar which implies demand of Dollar is at all time high & is going out of control… Now some analysts mention that RBI can intervene and pump in dollar from Forex reserve but fact of matter is that RBI can only intervene to some extent…We cannot finish our Forex reserves to control slide of Rupee otherwise else we will land our self in 1991 situation when our Forex reserve drained off completely & we were forced to adopt economic reforms though for the good of country.

Now if Gold demand keeps increasing and with devalued Rupee, Govt has to spent more Forex to import Gold therefore further depleting Forex (Foreign Exchange) and indirectly putting more pressure on Rupee (To devalue Further).

In real terms Gold is Dead Asset or i can say Non productive Asset, which i mentioned in my past Article also (You can read by clicking following link)

Indians simply accumulate Gold and never sell it off, until & unless they are in deep financial trouble..This situation arises once in 3-4 generations…Even after selling, the guilt feeling of selling Gold is so strong in Indians that they buy double the quantity when sunny days are back to overcome the guilt of selling inherited asset during need.. In short so called asset (Gold) is locked either in Bank Lockers or just increase the beauty of female members of the family. Even if Gold Prices touch Moon, People will not sell Gold.

When the Economy is in bad shape (I am referring to current situation). The urge to buy Gold increase manifold in order to hedge against Inflation or Bad Times….Actually increased demand are signs of poor economic condition rather craze of Indians towards Gold…Therefore demand for Gold Prices Increase & Proportion of  Gold in Asset Portfolio increase substantially…

With high demand, Govt is forced to import more Gold and shell out more Dollars to buy Gold which will put pressure on Forex and will not only impact valuation of Rupee but will also increase trade deficit (Which is going out of control). Depreciation in Rupee/Trade Deficit will further worsen the economic scenario and Indians will buy more Gold to hedge…..This is never ending vicious circle unless demand of dollar recedes to comfortable level.

Let me clarify, my intention is not to dissuade readers from investing in gold but to share right perspective so that we can take informed decisions…Gold is dead asset and does not give any return during holding period….We should allocate our assets wisely and Gold should not form more that 20% of our asset portfolio for healthy portfolio management.

Lastly there is one more angle to Trade Deficit i.e. Govt Spending on Populist schemes  like NREGA etc & to cover up the deficit created by increased spending, Govt bound to mop up tax collection…This increased taxation through retrospective tax amendement leads to negative investor sentiments & as i mentioned more than fundamentals, economy works on sentiments…Becoz of negative investor sentiments India is heading towards double dip recession…I will touch on this topic in detail in my next blog “Why India is heading towards Recession?”

Copyright © 2011-2012 Nitin Bhatia. All Rights Reserved.

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