Gold is often viewed by different people in different ways. It neither provides the excitement of Equity nor does it give “assured” returns of Debt Mutual Funds. Still there are many reasons why Gold should form part of your portfolio.
If you want to get to the point, then check this list of Gold Funds, else read on for more on the why and how of gold.
Hedge against Inflation
Gold is mainly seen as a “store of value”. It should be looked at as an alternative to currency. While currency can be printed (and demonetized) at will, Gold is the warehouse where you stock the value of your money. In other words, as currency loses value (what economists and now common men and women understand as Inflation), one needs to protect its purchasing power by converting the “cash” into gold. Gold provides the hedge against inflation.
Liquidity
Gold is arguably the most liquid of all non-cash instruments. Irrespective of where you are in the world, locating someone who will readily offer cash in exchange for gold is not difficult.
Source of Diversification
Diversification essentially means spreading out the investments across different asset categories such that the loss is one asset category is offset by a gain in another. However, if we spread across different asset categories which behave in a similar fashion, (i.e. gain in one is accompanied by a gain in another and loss in one is accompanied by a loss in another), then there is no benefit of diversification. In order to achieve the goal of spreading risk, one needs to diversify across asset categories that are “negatively correlated” or has “low correlation”.
Gold tends to have negative or low correlations to most assets usually held by institutional and individual investors whether it is in good times or bad. Hence it can reduce the volatility of the portfolio without necessarily sacrificing expected returns.
Protection in Financial Distress
Gold is the last bastion of value. Investors hold on to Gold knowing that, when everything else fails to work, gold can get them out of trouble. As uncertainty increases, investors prefer to “store” value until relative clarity emerges. Thus, when every other asset class is losing value, the price of Gold increases. It helps in protecting the value of the portfolio. Recent history such as Brexit, Trump becoming president, the rising trends of referendums and their results, combined with an increase in debt, liquidity driven asset inflation and currency wars do not point towards a stable global economy. There are risks that cannot be wished away. Markets in general and equity markets, in particular, are vulnerable to such macro disruptions. In this context, the yellow metal is likely to shine bright among all chaos.
How do I invest in Gold?
1. Physical Gold:
Gold can be bought in the form of coins and bars. The coins come in different sizes (1 gram, 2 gram, 5 gram,10 gram, 20 gram and 50 gram in India, 14mm, 22mm, jewellery etc diameter in the US, commemorative 1 US$ gold, and various such other forms).
There are many disadvantages of holding gold in physical form. It does not have utility value, can be lost (or stolen) and requires the investor to make arrangements for appropriately storing it. There can also be trust issues with respect to the quality of gold.
2. Jewellery:
One way to create utility value for physical gold is to convert it into Jewellery. There is a huge demand for gold jewelry, which is actually a manifestation of a demand for holding gold as a store of value. More than 60% of demand for gold is towards jewellery. Apart from the other disadvantages of holding physical gold, the cost of holding increases on account of high making charges and wastage taken by jewelers. The resale price is also lower as the jeweller deducts a small commission on the prevailing gold price.
3. Gold Investment in Mutual Funds:
This is increasingly becoming the mode of holding Gold from an investment perspective. They allow investors by units of a gold fund on the stock exchange. The gold fund is a passive in gold investment. Let us understand this with the help of an example.
M/s Glitter Asset Management company comes up with a Gold Fund, wherein it offers units to investors at an initial price of Rs.10 per unit. A person willing to invest Rs.1000 in gold can buy 100 units of this fund while a person willing to invest say Rs.50,000 can buy 5000 units. Totally, the fund collects Rs.100 crores from all investors, issuing 10 crore units. Let us say, the price of gold on that particular day is Rs.2,50,000 per kilogram. The Gold fund buys 4,000 kgs of gold. In the next one month, gold prices shoot up to say, Rs.275,000 per kilogram. This means the value of gold held by our fund goes up to Rs.110 crores (4000 kg *Rs.2,75,000 per kg). This translates into the value of 1 unit of the gold fund increasing to Rs.11 (Rs.110 crores of fund value / 10 crore units). Thus, a person who bought only 100 units of this fund sees an appreciation of 10% in his portfolio. If he wishes to sell his investment, he can redeem the units of this gold fund with the Asset Management Company at the prevailing NAV of Rs.11 per unit.
Thus, a gold fund facilitates small investors too. Since the fund is actually buying and selling the gold as well as holding the gold, there are no worries pertaining to quality of gold, storage and the risk of paying higher (making/ wastage, etc) or selling lower ( deductions). However, a small asset management fee has to be paid to the fund.
Conclusion:
Gold investment should be a part of every investor’s portfolio. However, its allocation should be around 5% to 15% of overall portfolio. One should not go overboard or overweight in this asset class. It should not be looked at as a trading opportunity.
