Dr Rajan, it's time for the RBI itself to buy gold - as Subbarao did in 2009

In November 2009, the Reserve Bank of India (RBI), which has always been preaching the virtues of not holding physical gold, bought 200 tonnes of gold for around $6.7 billion – or roughly $33.5 million a tonne – from the International Monetary Fund (IMF).

At current prices of around $1,106-1,107 per ounce, the value of the RBI’s gold purchase is more or less what it had bought the metal for in 2009.

If the RBI wants to tell people why gold is not such a good investment, it can tell its own story and prove its point. But it won’t do that, for a simple and logical reason: the purpose of holding gold as a reserve asset is to diversify risks, not to make capital gains by speculating in gold prices. This is the exact reason why most Indians buy gold when they can. So, despite all the bad press the RBI manages to give gold, they are on the same page.

This brings us to the second question: given that gold prices have fallen, and could fall further, what should the RBI do now?

I believe Raghuram Rajan, the RBI’s thoughtful Governor, should buy gold – in dribs and drabs - from the market at current prices. Some 200 tonnes of it can’t cost more than $7 billion, a drop in our current foreign exchange reserves of $353 billion, the bulk of it held in foreign currency assets worth $330 billion. Gold reserves are worth a mere $18 billion right now.

There are four reasons why the RBI should tank up on gold.

First, gold is value for money right now, even assuming its global price has not bottomed out yet. If buying 200 tonnes of it in 2009 at roughly the current price was a good decision, paying a similar price for it now is an even better decision.

Second, gold is the ideal counter-weight to excessive dependence on US dollar reserves. What if the dollar crashes in value? The dollar is the world’s preferred reserve currency, and its value has strengthened after 2008 not due to any fundamental improvement in the US economy, but due to the relative weakness of the European, Japanese and Chinese economies, which are busy printing currency notes to raise growth. As V Anantha Nageswaran writes in Mint newspaper today (11 August), “gold is anti-dollar”. This means when the dollar soars, gold will go weak in the knees. Both gold and the dollar are safe haven assets Diversification of risk means you have to buy both so that a fall in one can be counter-balanced by a rise in the other.

Third, in the RBI’s own case, as I have pointed out earlier, it is overweight in dollar. This clearly needs correction, especially when the euro, yen and Chinese yuan remain weak. China has devalued the yuan by 2 percent to boost exports , indicating that its economic weakness is still to be overcome. The EU, Japan and China may continue competitive devaluations and print more money, making the dollar king. But there is no certainty this will continue endlessly. At some point, all three have to revive. It is thus inevitable that the dollar has to fall and find a value closer to its real intrinsic worth. When the market makes that calculation, there will be a bloodbath in the currency markets.

Fourth, it is quite possible that if the RBI’s action end up increasing gold prices, demand from India could ease in the short run. Even though Indians have been immune to gold price volatility, the recent fall in prices is making Indians think of buying more gold right now.

As far as the RBI is concerned, it has to balance its US dollar bets with gold. When and if the dollar falls, the fall in the value of our forex reserves will be cushioned by our holdings of gold.

Rajan should be a contrarian in gold – just as his predecessor Duvvuri Subbarao was in 2009.