Gold – A Golden Investment!

Aren’t we all attracted to that shiny yellow metal?

Haven’t we all been gifted gold jewellery on our wedding by our parents?

Don’t we all feel more confident and feminine when we adorn gold?

Haven’t we all seen gold coins being gifted on auspicious and special occasions?

Aren’t we all wary of parting with our golden possessions?

Why are people going crazy getting shirts, masks, toilets and teeth made of gold?

India has a centuries-long affinity with gold. It is amongst the biggest consumer of gold worldwide. Gold is a favourite investment of all and sundry in India. Gold is valued as a monetary safeguard as well as status symbol.

As a country, we import around 800 tonnes a year, accounting for approximately 25% of global demand.

According to figures from the World Gold Council, Indian households are estimated to have so far accumulated 25,000 tonnes of gold (worth Rs. 110 lakh crore) – about 40% of the country’s GDP. This makes Indians the biggest hoarders of this precious metal.

How is the price of Gold determined?

But first, what is Gold? It is a commodity which falls under the “metals” category.

Shortages of critical commodities makes consumers anxious to acquire those products. While the producers would demand a higher price to bring more products onto the market, the consumers would pay a higher price in order to get the product they want. On the other hand, oversupply can have a devastating impact on a region by devaluing the prices of core commodities.

So, just like most commodities the price of gold is determined by the intersection of demand and supply.

Gold, as Warren Buffet likes to put it, is a Non-Producing Asset. It does not generate any income. A Kg of gold today will be equal to a Kg of Gold 10 years or 20 years later. Whereas, an acre of arable land can be used to grow crops to generate income, real estate can generate rental income or Stocks see an underlying business growth which leads to interest income. Hence, gold is not seen as a Wealth-creating asset.

However, it is increasingly being recognised as a mainstream investment. Global investment demand in gold has grown by an average of 14% per year since 2001 and gold prices have increased by almost eight-fold over the same period.

Why invest in Gold?

Gold benefits from diverse sources of demand such as: an investment, a reserve asset, an adornment and a technology component.

Investors choose to add gold to their portfolio for several reasons.

  1. Hedge – Beating inflation, combating deflation 

If you keep your money in the bank or in money market funds, inflation can eat away at its value. Inflation can be deceiving because your account balances won’t go down. However, when you take money out to buy something, you might notice that you won’t be able to buy as much as you used to. Therefore, if you don’t put your money into something that keeps up with inflation, you’ll soon find the value of your savings deteriorating. It happens when there is too much money chasing too few goods, so prices have to go up (because of an increase in the money supply). It is very damaging to your savings and investment portfolio. However, not all investments do poorly when inflation is high.

Gold tends to do well during periods of high inflation and can be a good investment hedge against inflation risk. In the years when Indian inflation was higher than 6% gold’s price increased by 11.5% on average. Thus, over the long-term, gold has not just preserved capital but also helped it grow. When inflation rises, value of the currency goes down and therefore people tend to hold money in the form of gold. Hence, in times when inflation remains high over a longer period, gold becomes a tool to protect against inflationary conditions. When people fear inflation, or mistrust governments or the financial markets, they tend to flock to gold thus boosting its price and helping it retain its value. 

On the other hand, during deflation, when you can purchase more goods with the same rupee, the demand for gold increases as people tend to buy more gold.

  1. Safe haven

Unlike currencies, gold is not directly impacted by interest rate decisions and cannot be printed to control its supply and demand. It has its own intrinsic value. Gold is a scarce asset that has maintained its value over time and has proven its worth as an insurance policy during adverse economic events. Because of this, gold is considered a safe haven by many investors. It has a negative correlation to stocks and other risk assets. The 2008-2009 financial crisis is a case in point. Stocks and other risk assets tumbled in value, as did hedge funds, real estate and most commodities, which were long deemed portfolio diversifiers. For example, the SENSEX fell by 56% from December 2007 to February 2009. Gold, by contrast, held its own and increased in price, rising 48% in INR over the same period.

Similarly, be it the 2011 – European Debt Crisis, or the 2015-16 China Slowdown and NPAs in India or the 2020 Corona Pandemic, gold continued to shine brightly.

Gold is long considered a beneficial asset during periods of uncertainty. It has gone up sharply even when every other form of investment has toppled during times of high risk.

Nevertheless, gold’s dual appeal as an investment as well as a consumer good means that it can generate positive returns in good times too.

  1. Liquidity

The gold market is large, global and highly liquid. The supply of gold is geographically diverse, thus limiting uncertainty and volatility. Gold supply is a combination of mined and recycled gold. Mine production is evenly spread across continents, contributing to gold’s low volatility relative to other commodities. The scale and depth of the market means that it can comfortably accommodate large buy-and-hold institutional investors. In stark contrast to many other financial instruments, gold’s liquidity does not dry up, even at times of acute financial stress.

Importantly too, gold allows investors to meet liabilities when less liquid assets in their portfolio are difficult to sell, undervalued or possibly mispriced.

  1. Portfolio Diversification

Gold’s unique attributes as a scarce, highly liquid and un-correlated asset highlight that it can act as a genuine diversifier over the long term. It’s utility as investment as well as Jewellery has allowed it to deliver average returns of approximately 9% over the past 10 years, which is comparable to Stocks and more than Bonds and Commodities.

Gold is a clear complement to stocks, bonds and broad-based portfolios. A store of wealth as well as a hedge against systemic risk, currency depreciation and inflation, gold has historically improved portfolios’ risk-adjusted returns, delivered positive returns, and provided liquidity to meet liabilities in times of market stress.

  1. Wealth preservation

Gold has been trusted by many investors for its wealth preservation qualities. Consider the comparison between owning Rs5000 worth of gold and owning Rs 5000 in cash in 1980. Gold has since gone up in value, its current value far proceeding the original investment. On the other hand, the currency note has not increased in value but due to inflation, it cannot even buy as much as it could have in 1980.

Around the globe, gold has a reputation as a safe haven asset during times of market instability and geo-political uncertainty. It holds great economic, aesthetic and emotional value that exists across time and borders. Gold is a diversifier against traditional as well as alternative assets and is considered a buffer against market risks.

The amount of gold allocated can vary according to individual asset allocation decisions. However, broadly speaking, the higher the risk in the portfolio –whether in terms of volatility, illiquidity or concentration of assets – the larger the required allocation to gold, to offset that risk.

Overall, extensive analysis suggests that adding between 6% and 17% of gold to an Indian-rupee based portfolio could make a tangible improvement in performance and boost risk-adjusted returns on a sustainable, long-term basis. Investors should not look at gold from the perspective of returns – they should look at gold as a means of protection.

And as goes with any investment, have a clarity on your financial goals before investing.

Leave a Reply

Fill in your details below or click an icon to log in: Logo

You are commenting using your account. Log Out /  Change )

Google photo

You are commenting using your Google account. Log Out /  Change )

Twitter picture

You are commenting using your Twitter account. Log Out /  Change )

Facebook photo

You are commenting using your Facebook account. Log Out /  Change )

Connecting to %s