The message from gold & real estate: 30th September 2009 Financial Express

Two apparently unrelated attractive investment avenues are real estate and gold both of which have shown similar proclivities of late. Conventional wisdom suggests that their prices must go up in the long run for the simple reason that they can never come down over such a period. This is why even rural India considers both of them to be safe investments and this is ingrained in our psyche. They also help to buffer against inflation and bring in capital appreciation to levels comparable with those on the stock market. However, while the long-run direction is clear, inter-temporal variations affecting them are quite different even though demand is typically from the same segment of users. Gold has been quite volatile in the last few years and has offered commensurate returns. Further, gold is not correlated with stocks meaning that it is a good product diversifier. The price of gold is inversely related to the dollar and typically, the weakening of the dollar strengthens gold. The recent race past the $1000/ounce mark was a direct result of the weakening dollar which has inched towards the 1.50 level (vis-a-vis euro). However, while India is the largest consumer of gold (20% share) we still remain price takers and not price setters which should have been the case. Hence, while at the margin, prices domestically are affected by demand factors, there is not much deviation from the international price with the correlation remaining above 95%.
The physical balances do matter at times, especially on the supply side when there are larger quantities in the market. However, the main source for the same, i.e. releases by central banks, is more or less controlled to ensure that there are no serious distortions in the market. The rising price of gold, however, does not deter consumption as it is purchased essentially for its quality of store of value and for purposes such as marriage, social mores and egotistic wealth. Demand tends to be fairly inelastic most of the time and demand is almost a straight line. Conjecturing the price of gold really means knowing how the dollar will move. This is tricky today as the dollar is declining despite the US current account deficit improving. This is so because global sentiment is adverse on account of the high risk perception of US assets. Countries are holding fewer dollars and have switched to the euro. The revival measures have.further caused consternation over the future of the dollar. Hence, the interest in gold will always be there with global cues being the guiding factor, while physical demand will simply be reacting to the prices that are being set in global market, COMEX in particular. The other phenomenon is real estate where prices have steadied after declining for most of last year. Typically the cycles follow a set pattern. Prices are demand-led where higher demand creates the supply as builders get into the act of making available housing spaces. But, prices do not come down to the same extent when there is a downturn in business due to the holding power of builders. The semi-oligopolistic set up ensures that prices never come down sharply even during these times and a correction of not more than 20% takes place at the best of times. Demand is driven by two segments, households and investors. The former have started investing in houses on account of lower interest rates being offered (one is not sure if they read the fine print of the limited validity on these rates), and the expectations that property rates will move up in future. The emergence from the slowdown has added to the demand for housing in recent times. Besides, the continuous migration of population to the urban centres has added to the demand for housing at the lower end. Also the expansion of companies into the suburbs of cities would keep up the demand for commercial property except during recession times. There is hence a positive correlation between economic recovery and demand for property. The other group of demand comes from investors who typically operate in the stock market and would move funds across to property when the time is right. Here the link with the equity segment is distinct where a longer term view is taken when the markets are down. Funds move to property and provide support for prices as they buy low and wait to sell at a higher price when conditions improve. This segment is typically less active when the stock market is up. Hence, while real estate sector is in a way indirectly dependent on the stock markets for seeking direction, gold continues to be an independent investment avenue for individuals. It is not surprising that all the markets are up today.