Crazy about Gold

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Passing through the street, during Diwali time, it is impossible to avoid the Dhan Teras advertisements by jewelers. As such we Indians buy gold all the time, in jewelry form or gold coins or bars or the latest fad, Gold ETFs and Sovereign Gold Bonds. But during Diwali, it reaches a feverish level unseen in anywhere else.

Indian fascination about gold run through ages where it was both used as currency as well as financial assets. Its a trait that is found not only in mere mortals but in Gods too. The popularity of a religious place can be gauged by donation it receives, mostly in Gold. Even thieves and criminals are not untouched by this idea. Couple of years back Vijaya Mallya was in the news for donating huge amount of gold to Tirupati temple. May be it was his idea of redemption for the huge amount of public and exchequer money he swindled away. From people wearing gold shirts to driving gold plated Jaguars, show of gold is seen as a social status. Acquisition of gold is considered a sign of rise in social hierarchy. One Indian musician, Bappi Lahiri, wears so much gold that it can break an ordinary mortal's neck, literally. Even financially suave Indian investors invest an out sized portions of their assets in gold ETFs or gold bonds.

Economists universally agree that gold is an unproductive asset. It has very limited industrial use and does not contribute to any productive economic activity unlike other asset classes like shares, bonds, deposits etc. Its notional value is based on a simple belief that eventually someone else pay more for it; a.k.a. Greater Fool Theory. Legendary investor Warren Buffett criticized investment in gold in a speech given at Harvard in 1998 by saying: “It gets dug out of the ground in Africa, or some place. Then we melt it down, dig another hole, bury it again and pay people to stand around guarding it. It has no utility. Anyone watching from Mars would be scratching their head.” Value of gold is just a social construct. It has value because every one else also thinks it has value. It has no inherent value like share, bonds, deposit or real estate.

So what is it that drives an unquenchable thirst for gold in Indian society or are the Indians making rational decisions in their own way? Lets analyze the reasons for so much gold buying.

1. Cultural affinity: In Indian culture, gold is associated with Goddess Lakshmi and prosperity. So any person who buys gold think, consciously or sub-consciously, acquisition of gold as acquisition of progress and prosperity. So gold purchase is often considered beyond monetary terms too. Gift of gold jewelry during marriage and other socio-religious functions is a regular phenomena in almost all Indian households.
2. Lousy Fiscal Policies: Decades of lousy pseudo-socialist fiscal policies have resulted in a stubborn inflation and very high inflation expectations. So Indian currency has depreciated enormously in comparison to currencies like US Dollar. USD to INR conversion rate has fallen from 1:7.80 in 1975 to 1:66.00 today (Source), resulting in a considerable loss of purchasing power for all Indians. So, conversely gold which is a not good investment in USD terms has performed exceptionally well in INR terms reinforcing the century old Indian perception of gold as a hedge against inflation.
3. Lack of other Investment Options: Majority of Indians are devoid of financial investment avenues like stocks, bonds etc. and interest in Savings account is so less that the money kept there rapidly lose its value due to inflation. Even majority of mutual funds struggle to outperform the index. Chit funds and Ponzi schemes swindle away public money from time to time due to lack of regulatory oversight. Moreover annual tax deduction of bank fixed deposits results in a considerable loss of principal itself for the investors. Black swan events like demonetization also enhances value of gold in Indian psyche.  

In the end, it can be said that, investing in gold is not an investment per se, but more like commodity speculation. But the lack of financial literacy, alternate investment avenues, inflation inducing and incoherent Government fiscal policies will continue to make gold an attractive investment options to Indian households for decades to come. However, investment in gold is unlikely to add significant value to the portfolio of professional financial investors.

What may be bad for Warren Buffett may not be so bad for common Indian investors.


P.S.: When I started to compose this article, the aim was to educate everyone about the fallacies of investing in gold, but during the research and analysis, I found out that for the lower strata of the society at least, gold is still an investment option. A bad one but some of the others are worse.