Gold: Security Blanket Or Speculator’s Dream?

The Reserve Bank of India’s recent tightening of gold loan norms, amid a sharp rise in gold prices, has unsettled stakeholders. While presented as part of a principle-based regulatory approach, the move bears the hallmarks of a countercyclical macroprudential policy.

Put simply, the central bank seems to be intervening just as gold’s performance is drawing heightened attention—possibly to cool speculative fervour.

It would not be far-fetched to ask: is the RBI smelling a gold bubble?

Gold has long occupied an ambiguous space in financial discourse. Is it a commodity, a currency, or a hedge against global uncertainties? Advocates continue to tout its virtues—it is relatively scarce, seen as a safe-haven asset, and acts as a hedge against inflation. These arguments are not new, but their validity in the current context demands scrutiny.

Way back in 2013, a former RBI Deputy Governor quipped, “if gold has been giving 37% return for the past few years, how can it be a hedge against inflation? The second logic is that gold is a safe investment. How come a hedge gives a 37% return…that means it has become speculative.” 

He had a point. A true inflation hedge is not supposed to generate outsized returns—it is meant to preserve purchasing power.

However, where he perhaps erred was in arguing against the use of gold as collateral. In India, pledging gold is a deeply rooted financial practice. Even the Indian government once leveraged its gold reserves to raise funds during a crisis in the early 1990s.

Speculative Surge
The recent spike in gold prices has revived interest in gold mining—a notoriously difficult and capital-intensive industry. Anecdotal evidence suggests that rising prices are prompting exploration efforts. Yet making long-term investment decisions in this sector is tricky. Gold prices are volatile. In 2013, they dropped nearly 30% in a single year—the first such decline in over a decade—driven by a strengthening US dollar, the tapering of the Federal Reserve’s quantitative easing programme, and a recovering American economy.

The future could hold similar headwinds: dollar strength, geopolitical shifts, a slowing global economy, and perhaps even the revival of American exceptionalism.

Even now, there are clarion calls from some “experts” encouraging everyone to add gold to their portfolio. One wonders what would happen to gold prices if everyone followed that advice. The statistical concept of mean reversion offers a powerful counterpoint—though it plays out in the long run, and what constitutes the “long run” is often hypothetical.

High-profile investors have also added fuel to the frenzy. Michael Burry—of The Big Short fame—invested in gold last year, lending credibility to the metal’s prospects. But history urges caution. As former US Federal Reserve Chair Alan Greenspan told Congress in 1998: “This decade is strewn with examples of bright people who thought they had built a better mousetrap that could consistently extract an abnormal return from financial markets. Some succeeded for a time… but they do not persist.” Mean reversion may be delayed, but it is rarely defied indefinitely.

The current gold rush may be driven less by rational investment and more by fear. When markets wobble and geopolitical tensions rise, investors instinctively gravitate toward perceived “safe” assets. Gold becomes a psychological hedge, not just a financial one.

This emotional component is difficult to measure, but crucial in understanding the present trend.

To see how speculative dynamics can overwhelm fundamentals, consider the food crisis of the late 2000s. Frederick Kaufman, writing in Foreign Affairs, traced the roots of the crisis to the creation of the Goldman Sachs Commodity Index in 1991. This index enabled long-only positions in a range of commodities. After futures markets were deregulated in 1999, financial institutions poured money into these instruments, transforming food staples into speculative assets.

According to Kaufman, this led to “imaginary wheat” dominating real wheat markets, with speculators outnumbering traditional hedgers four to one. 

Goldman Sachs later rebutted this in the same journal, with its spokesperson Lucas van Praag arguing that rising demand from meat-eating middle classes in emerging economies—not speculation—was the true culprit. Whatever one believes, the episode shows how financial innovations and institutional flows can distort markets in subtle yet significant ways.

Policy Dilemma
Back to gold: large institutional investors, central banks, and Exchange Traded Funds play a major role in price dynamics. When central banks accumulate gold, it sends a strong signal to retail investors. If monetary authorities are buying gold, should individuals not do the same?

Yet central banks face an inherent dilemma. The RBI, for instance, wears two hats—one as a forex reserve manager and another as a financial regulator. Other central banks, though not regulators per se, have also become purveyors of financial stability. This dual role complicates the narrative. While the RBI has made sizeable gold purchases as part of portfolio rebalancing, it also faces criticism over the performance of schemes like the Sovereign Gold Bond programme.

It is plausible that the RBI’s own gold gains have quietly offset these losses, but this nuance is often absent from public debate.
This raises an important question: should the RBI consider booking profits on its gold holdings, just as it does with foreign currency assets? If its gold portfolio has appreciated significantly, monetising a portion could support fiscal operations Yet doing so could send a signal of diminished confidence in gold. This balancing act is not unlike managing foreign exchange reserves—an art as much as a science.

Gold remains a complex asset—rooted in tradition, driven by emotion, and also influenced by macroeconomic factors. The RBI’s tightening of gold loan norms may be aimed at curbing speculative excesses, but it also highlights a deeper tension: how to regulate an asset that is simultaneously personal, widely held, and globally significant.

In this climate, investors must tread carefully. Gold may still be a hedge—but perhaps not in the traditional sense. It is no longer just a store of value; it is a store of sentiment, fuelled by fear, hype, and geopolitics. Whether that makes it safer or riskier depends entirely on the lens through which one looks.