A sharp and unexpected appreciation in the price of an asset attracts an investor's attention. At present, gold is at the centre of such attention.
As a rule, the higher the frenzy based on past performance, the greater the risk to the investor. If you are unable to hold your urge to jump in, the ironical implication is that you should be cautious rather than optimistic.
Since no expert has seen the future, any prediction about the price of an asset is prone to go wrong. New information can come in and negate earlier assumptions. Though experts have hinted at caution on gold for some time now, the events in Europe and global currency markets have kept the price high.
Investors should not simplistically assume that since prices have been moving up despite all warnings, it may be a good time to buy. As prices disregard logic and rise, the upside potential systematically reduces as the downside risk increases.
Investors see gold as a store of value and a safe haven. The risks in the global financial and currency markets, especially since 2006, have increased the clamour for the yellow metal. Since gold is sought after when other assets turn out to be risky, its usefulness in the wealth portfolio rises as overall risks increase.
This premium for gold has moved up due to the international events since 2008, and has increased more in the past year after renewed risks of recession in the developed markets. The investors who increased their allocation to gold during this period are now looking at decent gains in a market offering negative returns.
However, every consistent appreciation in value brings more investors, which creates a spiral in prices that are pushed up by the increasing number of eager investors. The performance then moves significantly away from its historical average, new justifications are provided for the price rise, forecasts of fantastic future gains float around, and doomsayers are left behind by the persistent increase in price. This configuration is a clear indication to a simple investor that it is not safe to buy gold now.
Such a strong view evokes the obvious reaction from investors, who like to think that gold prices can only go up. That is the historical perception. Let us go back to the basic principles and determine what drives the price of gold.
As a rule, the higher the frenzy based on past performance, the greater the risk to the investor. If you are unable to hold your urge to jump in, the ironical implication is that you should be cautious rather than optimistic.
Since no expert has seen the future, any prediction about the price of an asset is prone to go wrong. New information can come in and negate earlier assumptions. Though experts have hinted at caution on gold for some time now, the events in Europe and global currency markets have kept the price high.
Investors should not simplistically assume that since prices have been moving up despite all warnings, it may be a good time to buy. As prices disregard logic and rise, the upside potential systematically reduces as the downside risk increases.
Investors see gold as a store of value and a safe haven. The risks in the global financial and currency markets, especially since 2006, have increased the clamour for the yellow metal. Since gold is sought after when other assets turn out to be risky, its usefulness in the wealth portfolio rises as overall risks increase.
This premium for gold has moved up due to the international events since 2008, and has increased more in the past year after renewed risks of recession in the developed markets. The investors who increased their allocation to gold during this period are now looking at decent gains in a market offering negative returns.
However, every consistent appreciation in value brings more investors, which creates a spiral in prices that are pushed up by the increasing number of eager investors. The performance then moves significantly away from its historical average, new justifications are provided for the price rise, forecasts of fantastic future gains float around, and doomsayers are left behind by the persistent increase in price. This configuration is a clear indication to a simple investor that it is not safe to buy gold now.
Such a strong view evokes the obvious reaction from investors, who like to think that gold prices can only go up. That is the historical perception. Let us go back to the basic principles and determine what drives the price of gold.
NIRAJ KUMAR
PGDM 3rd Sem
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