24 November 2015 12:49:41 IST

Why ‘King Gold’ reigns supreme in the market for household savings

Portfolio theory recommends diversification of wealth, but the Indian housewife still swears by gold

Ramani is one of those thousands of women in cities who ekes out a living doing dishes, sweeping the floor, cutting vegetables, delivering milk sachets in the mornings and other chores in urban households. Nothing remarkable in that, you would say. That is true.

Nor indeed, for that matter, is the fact she became, the other day, yet another statistic in a city’s innumerable record of unreported crimes. She fell victim to a bunch of ‘Biscuit Bandits’ who steal gold and other valuables from passengers in trains. Only, in her case, it was not biscuits laced with strong sedatives, the standard modus operandi of these criminals, nor was it a train (it was on a Metropolitan Transport bus, actually). She lost her gold chain weighing all of two sovereigns, as she recounted, to a group of confidence tricksters travelling with her in the bus she had boarded to return home after attending a wedding in a nearby town.

Monetising Gold

To narrate in detail the process of how she was relieved of her precious holdings is at once tedious as well as a poignant tale of misfortune. I refrain from it not so much to spare your finer feelings from a discussion of the seamier aspects of life outside academia but from a recognition that it is somewhat out of place in a column devoted to discussing the arcane aspects of management theory.

But there is certainly a larger story in this poor woman’s tale of misfortune that we should all be concerned about, and one that is at the heart of the challenge that the Government is facing in monetising the private hoard of gold in the country, estimated at anything between 20,000 and 30,000 tonnes.

Two questions arise: What is the nature of competition in a market for private savings? How perfectly competitive is that from a retail investor’s perspective? Just to put it in context, against the vast hoard of private holdings of gold, the new Government scheme on monetising the yellow metal managed to garner all of 400 gm till now, according to a news report. Even against the lower estimate of 20,000 tonnes that is no contest at all. The Government is really up against it.

Gold has a place in the modern Indian psyche that is at once rational and yet challenges conventional notions about wealth that is founded on the rational behaviour of human agents.


Let us start with the notion of ‘risk’ in accumulating wealth. Modern portfolio theory in financial management sees ‘risk’ as a fluctuation in value arising from changed perceptions by the market, of future cash flows from an asset.

The lay mind, of course, would be concerned with any downward correction in such value, while being secretly satisfied with any upward adjustment that such a changed perception by the market might entail. Thus, if a debt instrument offering a certain cash flow based on its ‘coupon rate’, is valued at a price based on current perceptions about cost of money in the market today, it would be marked at a lower value the next day if the market expects interest rates to rise in the near term.

Of course, none of the foregoing discussion should lull us into a false sense of security that erosion in portfolio value (risk) is necessarily in tiny fractions. In theory, especially during periods of extreme turbulence, it is possible to envisage near total if not complete destruction of value of assets.

Also, such destructions need not always be the outcome of perceptions about interest rate changes in the economy. There can be natural, political or socio-economic reasons as well. It is for this reason modern portfolio theory also talks about diversification of wealth in a portfolio across different asset classes as a risk mitigation strategy. Whether the portfolio is worth ₹1,000 or ₹100,000 it is advisable to park it among different asset classes.

But the average housewife accords a place to gold in her portfolio of wealth, a place that is completely out of tune with any conventional notions of portfolio diversification.

Diversification, such as it is, is so miniscule as to be almost non-existent.

Accumulating wealth

That brings us to the initial question: How sensible was it for Ramani to have parked all her savings in gold and having done so, stepped out with all of it on her person, thus adding to the risk (total destruction of value)? If that is deemed risky that is nothing compared to a series of actions leading up to her accumulating two sovereigns of gold in the first place.

Each one of those actions was fraught with even greater risk. Take the act of purchase itself. Your average household servant does not walk up to the nearest Tanishq show room; buys a gold chain weighing two sovereigns; fishes out her credit card to complete the purchase and walks out.

The money is saved up in small amounts over a month. There is the risk, first and foremost, of the husband coveting it for his evening tipple at the local wine shop. If she overcomes that risk, she enrols herself in a jewellery chit scheme that requires her to put in a fixed sum month after month. A return on such monthly deposits can best be described as a miasma shrouded in illusion.

This is how it works. You are part of a 1,000 member group and one subscriber is chosen by drawing lots. The winner is thus freed from an obligation to subscribe to the scheme thereafter while retaining his/her membership. If it is a 60-month scheme, sixty winners contribute on an average for thirty months with the first member getting lucky in the very initial month and the last lucky one getting his turn in the 60th month. The group thus collectively earns a 100 per cent return over a five-year period which translates into a 20 per cent simple annual return for the group as a whole. But the group is 1,000-strong. So the return for each member is 0.02 per cent a year. All this while, the group is exposed to the price risk in gold as the gold is bought at the price prevailing in the 60th month. But the greatest risk of all is the prospect of the jeweller downing shutters and walking away with the cash citing business difficulties.

The risk of losing it all is inherent in the phenomenon of the not-so-rich parking pretty much all of their savings in gold. Viewed thus the loss of a gold chain to a group of ‘biscuit bandits’ is entirely in accord with how people value possession in the form of gold. So what explains this allure?

Wealth Generation

To understand this, one needs to go into the mechanics of how wealth is generated. Human labour, whether physical or intellectual, in the course of commerce gives rise to the production of some good or service having a commercial value. At this point it is actually a claim against another individual or a group of individuals. These claims can be traded for other goods and services having embedded within, someone else’s labour. To the extent these claims cannot be entirely exhausted in the acquisition of goods and services having their own labour values results in a surplus of actionable claims. The question then is, how one stores it. But all claims run the risk of repudiation (default) or erosion of value at some future date.

This is true even of claims on the Government in the form of debt securities. So why not store it in some physical good that is compact and hence easy to store. It should not be poisonous or hazardous to store. Additionally, it should not rust or waste away in any other manner. If it retains its original lustre then all the better. Unfortunately, in the list of elements found in nature, gold ticks all the boxes. There is a reason why the Pharaohs of ancient Egypt saw value in it as does the modern Indian housewife.