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Wednesday, March 21, 2012

Gold bubble worse now than in 2010/2011? RBI ED V.K Sharma feels so

One reason why the RBI is a thought leader, is that it promptly uploads any speeches/presentations of its senior management, thereby allowing media and others to analyze and report it. And many of those uploads have been fantastic-be it the Governor's caution on value of audit, Dy Governor's views on treating customers fairly, 10 commandments for a banking career, real reasons for inflation etc. One such fantastic insight was hidden away in a speech titled The Framework for Pre-Empting Systemic Financial Risks, an inaugural Address delivered by Mr. V.K. Sharma, Executive Director, Reserve Bank of India, at the World Risk Workshop 2012, organized by R-square RiskLab at Mumbai, India, February 6-7, 2012. Now, looking at the title itself, one might yawn at another post facto subprime crisis analysis. But in reality, this speech was quite incisive, not for the old idea of a gold bubble, but for cross triangulating it and backing with facts(read it here http://rbi.org.in/scripts/BS_SpeechesView.aspx?Id=675)
  1. If one looks at the recent readings, there is incontrovertible evidence that there is yet again a huge under-pricing of risks in the financial system and, therefore, it is not a question of if, but when, generic asset bubble caused by manifold increases in balance sheets of central banks will burst.
  2. Specifically, currently the global liquidity has become a bigger concern than it was in the pre-2007 period what with ultra-low and near-zero policy rates and major central banks’ balance sheets 1.50 to 3 times their pre-2007 levels, adding about USD 4 trillion in incremental central bank liquidity
  3. the over-valuation of gold - what we can also call gold bubble - with reference to 7 competing asset classes varied from 78% against highly correlated metal prices proxied by LMEX, 62% against WTI crude, 109% against US Treasuries proxied by JP Morgan index, and roughly 230-275% against Credit Default Swap index, Dow Jones, the US dollar index DXY and the US home price Case-Shiller index 
 The table below as explained in his speech is quite self explanatory. But what is alarming is that despite the talk about financial stability, regulation etc, things have actually worsened in the last 15months. I agree that taking data for period Mar00-Feb10 may have a base effect, since the starting point was in the dotcom aftermath. But a 10yr data set looks quite robust to me. And then, one must admire the methodology he has applied(past price history). It would have been great to apply earlier data from the 90s etc but then data quality may have been an issue.