Gold is no longer a safe investment

The crash in gold prices was one of the biggest shockers of 2013. A correction had already begun at the fag end of 2012, but prices really crashed in 2013, triggered by fears that the US Federal Reserve would scale down and do away with the economic stimulus.

However, Indian investors in gold were cusioned against the crash due to the fall in the rupee. As the dollar became costlier, gold continued to fetch a higher price in India. Besides, the government introduced certain measures that pushed up the domestic price of the metal. Import duty on gold was hiked from 2% to 10%, increasing the landed cost of gold. Quantitative restrictions were also imposed on gold imports, such as the RBI's 20:80 scheme, which mandates that 20% of imports need to be re-exported .

As a result of these measures, domestic prices of gold have receded by only 4.3%, compared to the 28% drop in global gold prices during 2013.

This gap in the price of gold has created an opportunity for 'legal smuggling' of the metal. NRIs returning to India after spending more than six months abroad are allowed to carry up to 1 kg of gold. Jewellers are using NRIs as carriers , even offering to pay for their air fare if they bring in gold for them. Even if they pay the import duty of 10% on bars and coins or 15% on jewellery, the arrangement works out to be profitable (see table).

The wide difference in the domestic and international prices of gold have led to another anamoly in the capital market. The market price of gold ETFs, which is based on the domestic price of the metal, is far higher than their NAVs, which is based on the landed cost of gold. The difference is as high as 10%.

Since gold has rallied for more than a decade now, most investors had begun to believe that gold prices can only go up. However, the crash in gold prices has shattered this myth, at least for the global investors. This explains why they are now dumping gold. The gold holdings in SPDR Gold Shares, the largest gold ETF in the world, have came down from 1,351 tonne at the end of 2012 to just 814 tonne now, a fall of around 40%.

Lessons from 2013

1) Gold is no longer the safe haven it used to be. Its price can also come down, shattering a long held belief.

2) The currency dynamics and policy measures can lead to a significant variance in domestic and global prices.

3) Paper gold is not always the best way to invest in the metal. Gold ETFs are trading 10% above their NAVs.

Strategy for 2014

International gold prices may continue to correct in 2014. "We remain bearish on gold because it will underperform during tighter liquidity and rising interest rates scenario. It may go down further to the $1,050-1 ,080 range before March 2014," says Kishore Narne, associate director, Motilal Oswal Commodities Broker. Domestic gold prices have been cushioned from the global crash but this could change in the new year as the government rolls back some of the harsh measures introduced in 2013. A reduction in the import duty and other restrictions can bring down the domestic gold prices. "Domestic gold also looks bearish; the only risk is the currency," says Narne. Investors will have to monitor global developments and government policy measures more closely in 2014. Financial advisers have long advocated the benefits of buying paper gold. This conventional wisdom has been turned on its head by the differential in the market price of gold ETFs and their NAVs. It's better to stay away than get caught on the wrong foot. Getting gold from abroad for a jeweller may seem a great way to earn easy money, but there are several glitches in this arrangement. The tax department may want to know where you got the money to buy the gold. Since this involves profit, you would also have to pay tax on the gains. However, it makes sense for NRIs to bring in small quantities of gold

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