Trillion dollar question: why do Indians prefer gold? Retail ownership of Indian equity is at an all-time low, while that of gold is at an all-time high.

During my childhood, I was fascinated by the story of a young trader making a trip to Java in search of a fortune. Rescued by a passing ship, he survived a storm that had sunk his ship. While staying on the ship he noticed an unusual paper weight in the captain’s cabin. He requested the paper weight as his compensation for working on the ship. Even though he was ridiculed for asking a pittance, he insisted on the paper weight. In the end, he made a fortune as the paper weight was a rough diamond which the captain hadn’t noticed. I read similar stories about how natives in the US, Africa and Latin America bartered their valuables with visiting traders.

I used to think that such a quick-way-to-be-rich opportunity existed only in stories. And always believed in the idiom that you can fool some people some time but you can’t fool all the people all the time. In today’s world of connectivity and 24x7 news coverage, how can one trade on unfair terms? Everyone knows the value of goods being sold, especially in the financial markets, where exchanges have made price discovery transparent.

My two decades-plus experience in the Indian equity market has forced me to conclude that the average retail Indian investor is as naive as the captain of the ship or the natives of the US and Africa who gave away their valuables too cheap.

In the 1970s, India forced multinational companies operating in India to get listed on Indian stock exchanges. That one single decision created more wealth for Indians than most of the welfare schemes. A few of the companies that left in protest came back with more vigour (and money) to cover for the lost decade. In the pre-liberalization days of the 1990s, barring foreign direct investment, foreigners did not own any equity in Indian companies. Retail investors owned a substantial part of the companies listed on the Indian exchange. In many blue-chip companies, their ownership was higher than that of the promoters and institutions put together. Over the years, retail investors have been buying gold and selling equities on an unprecedented scale.

Retail ownership of Indian equity is at an all-time low, while retail holding of gold is at an all-time high at more than 20,000 tonnes (excluding unaccounted gold). Retail investors have consistently played the trade of long gold and short Indian equity without any stop loss. They are obsessed with the mentality of doubling their not-so-profitable trade rather than switching the trade. Retail investors are not realizing that if they (the largest buyers of gold in the world) stop buying gold, prices can correct. They are unable to visualize that if they (the largest holders of gold in the world) sell their holdings, prices can come crashing down. I shudder to think what will happen to gold prices when Indians stop buying or start selling gold. Introduction of the gold standard is the only saviour for Indians but the probability of it being introduced in the current era is very low.

Data shows that many stocks as well as the broad market have outperformed gold between 31 January 1991 and 31 December 2012 in dollar terms. During the period, while some of the stocks returned up to about 33%, the Sensex gave 9.07% compared with gold’s return of 7.18%. This calculation has been tilted in favour of gold as it does not take into account dividends and its reinvestment. It does not take into account the premium that investors pay in terms of the price for buying smaller denomination of gold or quality and making charges for buying in the form of jewellery.

So why are retail investors acting so naively? Why are they not able to look at the past to do a sanity check? Why are they not able to look forward and think about who will buy from them and at what price? Why are Indians sending their savings to gold exporting nations and selling the golden entrepreneurs at a cheap price to import global savings?

That is a trillion dollar question for India and has many aspects. In the next column, I will make an attempt to view the same from the market point of view like the blind man trying to define an elephant.

Nilesh Shah is director, Axis Direct.