The Different Perspectives on Gold Investment
Gold is often viewed by different people in different ways. The enthusiasts will always vouch for the purchase of gold saying that its value will never fall, promptly buying physical gold (read ‘Jewellery”). Gold Investment is the one that the lady of the house will invariably support! However, Gold prices have seen far too many fluctuations in the last few years prompting many investors to reject it as an investment class (compared to other Mutual Fund categories) with a lot of risks and no commensurate return.
Gold neither provides the excitement of Equity nor does it give “assured” returns of Debt Mutual Funds. Hence, we have more of a lukewarm response to a suggestion of Gold Investment. Does Gold merit a place in the portfolio, for reasons other than social and religious purposes? There are many reasons why Gold should form part of your portfolio.
Gold As A 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 the 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 a hedge against inflation. As the purchasing power of currency falls, everything becomes more expensive in monetary terms. You no longer get your favourite vegetable for Rs.2 /kg. The cup of tea that refreshes is now in double digits. The story is similar for almost everything. However, you cannot store value in a cup of tea or in vegetables. These items are perishable and hence, the value is lost if we stock up on them as protection against inflation.
However, with Gold, it works like a bank in which you deposit the value of your currency and when you withdraw, you get the same value back. To use a very simplistic example, if Rs.100 can buy 10 chocolates in year X but only 9 chocolates in year X+1, it means the currency has lost value. If you do not wish to buy chocolates in year X but store your money to buy them in year X+1, you actually lose out, as you get lesser chocolates. However, if you buy gold with your Rs.100 in year X, and you sell the gold in year X+1, you will get money with which you will be able to buy 10 chocolates. The price of gold would have increased by the same proportion as the fall in the value of the rupee. Thus, Gold is a hedge against inflation.
Thus, we see gold as a protection against the risk that prices of various items would go up (which means loss of purchasing power of the currency). If one invests in gold, one is protected against this risk as the value of gold would also go up proportionately.
Liquidity: Gold’s Advantage In The Market
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. Transparency on the price of gold in the global markets, clarity with respect to purity of gold (18 karat/22 karat/24 karat) along with certifications (BIS/Hallmark) has made it easy even for retail investors to trade in gold.
Source of Diversification
One of the important lessons learned in school was “not to keep all your eggs in one basket.” The jargon equivalent of this in financial markets is called “diversification.” Diversification essentially means spreading out the investments across different asset categories so that the loss in one category is offset by a gain in another. However, if we spread across different asset categories that behave in a similar fashion, (i.e., a gain in one is accompanied by a gain in another and a 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 have a “low correlation.”
A negative correlation means that a rise or gain in one asset category is usually accompanied by a fall or loss in another asset category. A low correlation implies that the rise or fall is not in a similar proportion. 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. Gold in a portfolio 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. Thus, Gold 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 toward 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.
Thus, Gold should be part of every risk-averse investor’s portfolio. Nothing untoward may happen and Gold might just return the equivalent of inflation. However, if there is a crisis waiting to unfold, Gold will be the protection your portfolio will need.
Conclusion:
Gold investment should be a part of every investor’s portfolio. However, its allocation should be around 10% to 15% of the overall portfolio. One should not go overboard or become overweight in this asset class. It should not be looked at as a trading opportunity. While gold funds and sovereign gold bonds appear to be the best way to hold gold, the choice really boils down to what one feels is convenient for oneself.
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