Investment is always fraught with risk. And with most investments losing value in recent times, many people have begun looking at gold again. But is it safe to invest in gold? There are three ways to answer this question.
The first is the price at which it is bought. Like any commodity, there are highs and lows. If gold is purchased at the high level in its price cycle, it will take some time to recover cost of investment.
A classic situation took place in 1980 where for a short time on a single day, gold prices scaled $800 (Rs39,920 now) an ounce. Those who bought gold then had to wait for at least 20 years before prices reached that level again.
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Another way of looking at gold is as a hedge against inflation. Gold has (almost always) registered higher average price increases than average inflation rate in most countries. Moreover, unlike any other commodity, it shows little volatility.
The third way to look at gold is how its price appreciates. For instance, if one considers a 20-year period (the normal time frame for an individual to encash the benefits of his savings), gold was a marvellous investment in dollar terms. But as Indian prices were always higher than international prices, anyone who invested in gold at prices prevailing at that time will feel the pain of not seeing his investments pay off. So, never buy gold in India without comparing international prices.
When central banks sell gold
Any investor would be right in trying to find out why gold prices did not rise much from 1985 to 1998. There are three major factors. One is speculative forces. It may make sense for investors to compare spot prices of gold at which the metal is purchased and then compare them with gold futures prices for three-month and six-month positions. If the difference is too great, be cautious.
The second is to keep a lookout for gold sale by central banks of countries, which usually happens when the dollar is strong. This is because the world normally backs one major currency or commodity at a time. When the dollar is strong, money gravitates to it, and when it is perceived to be weak, a lot of money parks itself in gold at such times.
During the 1990s, most European countries and a few others (plus the International Monetary Fund, or IMF, and the European Central Bank by tacit consent) decided to enter into an agreement—the Central Bank Gold Agreement, or CBGA—that gold would continue to remain an important element of global monetary policy. But they also recognized the need for central banks to sometimes sell gold to meet domestic financial obligations.