Indians are known to be savvy investors in gold.

They have continued to import /buy the yellow metal for the last 10 years or so in enormous quantities at relatively low prices.

If anything, volumes have been rising with every rise in price; and such price rise created wealth. In 2005, 10 gm of gold cost Rs 6,000. Prices steadily gained and hit Rs 32,000 in 2012 following a surge in international rates and a weak rupee.

However, those who entered the market in the last 15-18 months after prices moved well above Rs 27,000/10 gm (with hopes of further price rise) but did not exit the market in time may have cumulatively suffered losses of Rs 25,000-35,000 crore following the recent crash in gold prices.

There are reports that despite the precipitous price fall, Indians are once again lapping up gold like bargain hunters.

‘Averaging’

On the face of it, this may appear paradoxical; but there is a logic. One strong reason for this phenomenon is that having lost money, buyers now want to reduce the losses by what is called ‘averaging’ in trade parlance.

For instance, suppose I had purchased 10 gm at Rs 32,000 last year, then I have lost about Rs 5,000 in value due to the latest price fall. However, if I invested in an additional 10 gm now and bought at the current price of say Rs 27,000, then my total cost is Rs 59,000 (for 20 gm) and the average price becomes Rs 29,500/10 gm. My loss is reduced to Rs 2,500. It is likely that some of the smart investors are doing this now. Of course it assumes that such smart investors have spare cash to invest for the purpose of averaging.

But is such additional investment prudent at this point of time? Where is the gold market headed? From the late 2012, gold prices have softened in dollar terms as well as in rupee terms. Return on gold investment in 2012 turned out to be much less attractive than in the previous several years.

With the recent meltdown, demand for the yellow metal as an investment asset is sure to take a beating. While physical demand for household consumption (say for weddings and so on) will stay robust because of price elasticity of demand, investors will surely turn more wary of putting more money in gold.

Demand Slowdown

A slowdown in investment demand is sure to drive domestic prices further down. Additionally, the tendency to expect even lower prices can make buyers stay in the sidelines. While it is rather tough to crystal-gaze the direction of gold prices from here on, it appears that the downside risk to prices is far greater than an upside risk.

From the supply side, while scrap sales may reduce at the current low prices, from a mine supply perspective, the marginal cost of production is still well below the current price of $1,400/ounce. Therefore, any threat of mine closure and supply disruption is illusory and not real.

Second, the possibility of some countries including some European ones selling gold to tide over financial difficulties cannot be ruled out. Further outflows from physically-backed exchange traded funds can put additional downward pressure on prices.

At the same time, crash in gold prices and more benign crude oil prices are sure to benefit India. Given that these two commodities account for large outflow of foreign exchange, lower prices will not only help bring down the current account deficit, but also prevent the rupee from depreciating.

If anything, the rupee has the potential to firm up and lower the landed cost of gold in rupee terms. So, there is still some downside left for gold prices to probe, both internationally and domestically.

In dollar terms, it could go as low as $1,300/oz and even lower. In the event, in rupee terms, Rs 25,000/10 gm may become a possibility.

Upside risk to gold prices may come unexpectedly from adverse geopolitical developments, renewed worries over European debt crisis or injection of more liquidity.

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