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GOLD BUGS ARE BACK. Why are gold prices rising? What are other gold investments?

Author: Kumar Shankar Roy/Wednesday, August 14, 2019/Categories: Exclusive

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GOLD BUGS ARE BACK. Why are gold prices rising? What are other gold investments?

NIFTY means National Stock Exchange Fifty, the country’s benchmark broad based stock market index for the equity market. However, for 'gold bugs' NIFTY means ‘No Income For This Year', and BSE Sensex is ‘Bombay Se Exit’. 'Gold bugs’ are laughing at the expense of equity market investors although Indian markets have rallied in the last two sessions, partly reversing recent losses. While Nifty reclaimed 11k mark and sensex climbed 37K level on August 8, gold prices crossed the Rs 38,000 level. Gold as an asset class is doing better, reason why the 'gold bugs' seem to be having a good laugh.

Gold Hunger

India is known for its hunger for gold with households piling up around 24,000-25,000 tonnes of gold, making the country unofficially the world's largest holders of the yellow metal. Kerala, known as the God’s Own Country’, can well be called the ‘Gold’s Own Country’ as the state is the largest consumer of gold.

In India, gold has sentimental value. It is also seen as the protector of wealth. In a world where currency money can be demonetized, people think, gold is equivalent to any currency and the language of gold's economic value is understood in those terms.

Gold Prices Rising, Here’s Why…

Gold is shining bright with 26% rise in domestic prices over the last year. Globally, the prices of gold have risen. Spot gold prices traded at $1,505 an ounce driven mainly on the geo-political tensions between the US-China. The Federal Reserve rate cut and drop in rupee versus the US dollar gave support to the prices of precious metals. Gold has a field day whenever there is risk aversion.

"Economic data is increasingly showing signs of stress globally. The fiscal stimulus given a decade earlier and tighter financial conditions is causing economic deceleration. This is not only impacting the goods sector but is also affecting the services sector. However, the central banks are terming this situation as cyclical. The trade war and signs of a currency war have acted as a catalyst in the dramatic rally of gold," says gold expert Chirag Mehta, who is senior fund manager-alternative investments, Quantum MF.

As long the US dollar, which is usually a headwind for gold, depreciates or remains range-bound, ‘gold bugs’ will enjoy price movement. The moment the dollar starts appreciating, gold price subsides as the tension in the air comes down.

Despite gold having no real earnings or creation of economic value, it is fear of the uncertain future that pushes the demand for gold. Demand pushes up price: that is economics 101.

Is gold a good bet?

Now, that is the moot question. As an investor, you should lead your investment portfolio like Virat Kohli leads the Indian cricket team. You should get the best out of your team members. To get the best out of them, you need to play them in matches. Because even the best player cannot score runs or take wickets if you keep the player on the bench! The same logic applies to your investment portfolio. Just because gold is doing well today, it does not mean that gold has been a wealth creator over longer periods of three to five years or even more.

Data shows that gold may have done well, but it is a poor investment allocation. Despite rising by 26% in last 12 months, the three year return of domestic gold is 4.5% which is almost 4% saving bank account interest rate. The five-year gold price gain, despite the last 12 months' superlative return, is 5.7%. That is less than what you make from a bank Fixed Deposit (FD). If we take the Sensex as a yardstick for gold, you will notice that equities, which have done badly in the last few months, could be a better asset when it comes to financial returns. The Sensex has given 10% CAGR over three-year period, almost twice of gold.

Over the five year period, equities have given 8.2%, a bit more than gold. But every financial asset will have its moment of ups and downs. Remember gold prices dropped in 2013 and 2015.

“Historically, the performance of gold is not structural. “It generally performs in specific short periods of time, especially during capital market meltdown or global recession or geopolitical tension, etc. Therefore, it may not be an ideal long term asset class," observed analyst Sachin Jain of ICICI Securities in a mutual review note.

Not just physical gold…

Gold can be bought in many forms --- bars, coins or jewellery. There are gold investment products like gold exchange-traded funds (gold ETFs). There are also stock funds of overseas gold miners. In India, the government offers Gold Sovereign Bonds (SGBs), the latest offering closed on August 9. Among these, gold bonds could be the best bet. Gold bonds pay a fixed interest plus the capital appreciation if the price of gold in the market goes up. This makes gold bonds much better than just keeping gold or investing in gold ETFs.

Gold is not a bad asset…

You should have gold, but not too much. A 15% allocation to gold in your portfolio will hold you in good stead. The problem is only when you start adding more gold. Gold prices have risen by 26% and if this stays till the end of the year, your annual investment portfolio review should contain steps to bring down gold allocation to 10-15%.

Complete indifference to gold, debt, equity or cash is not a wise decision though. Gold remains a good portfolio diversifier, but don’t fall into the trap of 'gold bugs' who always think the yellow metal is the best bet.

Gold is likely to give long term returns of 6-8%. Can your financial goals be met with those returns? If your financial goals will require more returns to be achieved, you have to branch out to equities/stocks. Do remember that equities, fixed income or any asset that is looking bad today are going through a cycle. But an investor can capture the upside to any asset only when he/she is a little counter-cyclical. When the asset price has already gained a lot, there is little profit to be made.

Gold bonds give a fixed return in addition to capital appreciation.

Since most investors chase returns, the lure of being exposed to gold returns is increasing. Is it 100% equity or 100% gold? Both the approaches could be bad for an investor. For an average investor, it is better to have a portfolio where each financial asset has a good role to play. This means the ideal investment portfolio should have a bit of equity, fixed income/debt, gold, cash and assets overseas if possible. Remember, gold jewellery in all forms should be avoided as it involves labour cost and jewellers pass on this hidden cost to the buyers in the form of making charges. There is a difference between the buying rate and selling rate of gold. Purity of gold is another issue. In India, traditionally most gold jewellery is sold under the purity of 22 carat although there are several other standards. Some jewellers adulterate the yellow metal with other metals. Finally, safety is a key aspect one must look into while buying gold jewellery as keeping gold at home is not a safe proposition. (The author is a journalist with 14 years of experience)

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