Losing Lustre

When gold prices crossed $600 we had asked whether gold was a great investment option. Gold bulls were sanguine that it would cross the old high of $850, made sometime in early 80s. We were not so sure. After our analysis, gold surged past $700 in a month. But after touching $730, a 26-year high, the yellow metal started softening until on June 13, it posted its steepest one-day decline in 23 years! Gold simply collapsed 8% in one day to almost $550 when a global liquidity crunch forced a selloff of all risky, leveraged assets - from emerging market equities to commodities - and gold. The reason: the strong market opinion that the US Federal Reserve may keep raising rates to contain inflation. This reduces gold's appeal as an investment. This is why we had suggested investors avoid gold at these levels.

The key point about gold is that unlike other financial assets, it does not pay interest or dividend. So, the moment there is a reasonably safe asset class that seems to offer a stream of income - and does seem strong enough to withstand economic risks, money will flow into that asset, deserting gold. This is exactly what happened in mid-June as the dollar re-emerged as a strong competing asset because US interest rates were expected to harden.

Investors embrace gold as an asset when they have no asset to turn to - a period of extreme depression and gloom. This is rare in human history and so, despite periodic appeals, in inflation-adjusted terms gold has been a terrible performer.

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