Gold: The risks of landing on a market infested by speculators


There was a debate recently in Mauritius as to why the Bank of Mauritius should not be buying up gold to diversify its international reserves. The view was taken that the price of gold will keep rising. Accordingly, that would be an opportunity to make money by selling gold at a higher price than what it cost originally.

The suggestion was also made in the context of prevailing near zero interest rates being earned by Mauritius on most of its foreign exchange reserves invested in currencies like the US dollar and the Euro. Since the international economic downturn was giving no sign of reversing any time soon, there was the risk that western central banks would keep their interest rates at rock bottom levels for quite some time to stimulate economic activity at home, thus jeopardising our chance to make reasonable returns by way of interest earnings on our foreign exchange reserves.

On the other hand, the US dollar kept dropping in value against other currencies while the price of oil appeared to be maintaining itself up against the background of geopolitical tensions in the Middle East. In circumstances of uncertainty such as this one, investors (including speculators) divert their funds into gold, which is regarded as a safe haven, away from currencies and stock markets.

The global stock of gold hardly increases today by some 2,000 tons per annum through mining. Most gold mines are completely exhausted and it takes a decade before a new mine starts yielding, which makes the supply of gold highly inelastic to price movements. Any sudden pressure of investment demand for gold tends therefore to hike up its price immeasurably. In 2001, gold was being traded at $380 an ounce (oz). The economic crisis came in 2008 and, with it, the flight of investment into gold as a safe haven. As a result, by December 2009, the price of gold shot up to $1200/oz.

In 2010, there were dire forebodings about the sustainability of the Euro and, hence, about the integrity of the European Union itself. The associated risk fed into global economic uncertainty. Not surprisingly, the price of gold escalated to $1432/oz by March 2011 in the background of the building up of risk. An uncertain political situation in America, with no sign of the world economic depression abating, money continued to find its way into gold the price of which increased further to the record high of $1913/oz by August 2011. Today the price has come down and is hovering around $1680/oz as it is believed that there is a better chance of global economic upturn now than it was the case in 2011.

Thus, those who purchased gold at $1913/oz in August 2011 in the hope that its price would not come down so soon, will be making a loss of $233 per ounce of the precious metal if they were to dispose of it within a relatively short interval. Reverses like this are not uncommon. For example, when the international regime of floating exchange rates was introduced in 1973, an ounce of gold was priced at $42. The price stayed at this level for a number of years but that situation encouraged a lot of buying up of gold by individual countries. By January 1980, the price had shot up to $850 an ounce in the wake of the international oil crisis.

This sort of price hike is not unidirectional however: as fears about declines in stock markets, further fall of the US dollar’s value and rising inflation receded subsequently, investors moved out of gold bringing its price down. From $850/oz in January 1980, the price had come down in the process to as low as $380/oz by 2001, reflecting a loss of $470 per ounce of gold held. A lot of speculation prevails on the gold market and one has to be on the constant watch so as not to face a severe loss once the market dips into the opposite direction.

We understand that the Bank of Mauritius has acquired in the meantime some additional amount of gold to add to its foreign exchange reserves. Whatever the price at which this gold was acquired, the BoM will have to be on a watch out of the gold market. Knowing the price at which the additional gold was acquired by it, the BoM should be able to sell it back at a profit by pre-empting any fall in the price relatively to its purchase price. This requires the BoM to be able to sell away at short notice.

Gold price will come back to more normal levels compared with today’s $1680/oz the moment economic clouds start disappearing from global markets. Having decided to embark on the gold market more substantially than before, the BoM now needs to track the actions of speculators on the gold market in case they move out of gold in future and go for more rewarding and less risky other assets. We can only hope that the decision to invest more fully in gold by the BoM was worth the candle.

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The Path Travelled by the MRA so far

Not many departments of the government come out in public to lay down their balance sheets. The Mauritius Revenue Authority (MRA) is an exception in this regard. Its Director General came in front of the media this week to explain its realisations in recent years. The picture that comes out appears to prove that the establishment of the MRA as a consolidated revenue department of the government in 2004 was a well inspired move.

It is well known that without sufficient tax collections, the government would not be in a position to expend resources towards maintaining welfare programs. It comes out from the figures presented by Mr Sudhamo Lal that progress in tax collection has been sustained over the years. Some of the progress can be attributed to collections growing naturally with the pace of growth of GDP. Where, however, the rate of growth of tax collections is higher than the rate of growth of GDP, tax growth can be attributed to only two causes. They are: (i) policy changes, and (ii) improved tax collection efficiency. Both these factors have been at play when accounting for the recent years’ faster rate of growth of tax collection than the pace of growth of GDP.

The MRA has been very effective to close down tax loopholes in many places where they existed. Its hunting grounds in this respect have been opened out and we should expect more dividends from this opening in future. This approach to go out seeking for potential tax payers has culled up new sources of tax revenue. The MRA has kept targeting tax evaders as well. Many have been brought into the tax net who would have walked out of it in the absence of a watchful follow-up framework.

A positive fallout of tax evasion tracking is the possibility it confers on governments to give relief where it is most needed thanks to the additional revenues collected. The final effect is to make the tax system fairer towards the honest taxpayer by making the average tax effort of taxpayers more bearable than if many had managed to escape from the tax net. Mr Lal should be encouraged to pursue this route for achieving a fairer distribution of the tax burden.

Another positive factor is the MRA’s increasing adaptation towards securing tax returns and providing tax information on the digital platform. Apart from cost-saving for both the taxpayer and the tax collector, the current shift in this direction should improve the dynamics of the tax system, making it more real-time and accessible to all concerned from any part of the world.

Much good work has been done towards making more efficient our system of tax administration and one can only hope that other government departments would come out just as well to state to the public how efficiently they have been performing to accomplish their distinct missions. Moving in this direction will only help to build up the confidence factor in the upkeep of our institutions.

* Published in print edition on 18 January 2013

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